If you’re reading this, you might be a professional real estate investor who has spent decades in the industry.
Or you might own a second home which you rent out to a tenant.
Or anything in between.
But if you own real estate of any kind, then you are a real estate investor, whether you consider yourself one or not. And that is why real estate asset protection is a concern for you.
Our firm has helped all types of real estate investors, from small to large, and we can stress the importance of planning ahead. You stand to risk a lot of you are sued, particularly in the state of California, where it is very easy for a tenant to file a lawsuit against a landlord.
We could write a whole article about the different types of lawsuits that real estate investors face. They include matters such as:
- Illnesses and injuries that occur on your property.
- Data breaches that reveal private client information.
- Contractual disputes regarding the lease or other agreements.
- Misrepresenting the property or failing to disclose certain risks.
- Environmental hazards such as lead paint or asbestos.
- Discrimination based on race, sex, orientation, disability, or other factors.
And there’s a lot more, too. As a real estate owner, you have a very high duty of care to your tenants, and the potential for being sued is as broad as the potential for anything to go wrong.
Now, you might think that if you’ve acted ethically, you have nothing to worry about – and it’s true that the first line of asset protection, in real estate or elsewhere, is to try not to do anything that could get you sued.
But this isn’t enough. Even if a lawsuit against you is groundless, you will still spend a lot of time and resources fighting it. And since most lawsuits (well over 90%) are settled before going to trial, you will probably end up paying some damages to the plaintiff, even if you did nothing at all wrong.
Also, merely being a real estate investor – especially a big one – places an enormous target on your back for unscrupulous lawyers who are looking to push baseless claims. Even relatively cheap real estate investments are worth a lot of money, and money attracts lawsuits like flies attract honey.
If you take steps to protect your assets, you will be in a much stronger position if and when you get hit with a lawsuit. There are several layers of asset protection that you can place around your real estate properties, and the more of these you implement, the stronger your hand will be. Each type of asset protection, however, has its own advantages and drawbacks.
The Homestead Exemption: Not Enough for a Real Estate Investor
You’ve probably heard of the homestead exemption, which allows you to retain some equity in your home after you declare bankruptcy.
The homestead exemption can be very useful to those in a tight spot. If you go bankrupt, then it can protect as much as $600,000 worth of equity. However, this only applies to your personal residence, the one which you both own and live in. It provides no protection to investment property which you rent out.
Besides, you don’t want to get to the point of bankruptcy before your asset protection plan starts kicking in.
So don’t allow the homestead exemption to lull you into a false sense of security. If you’re a real estate investor, it’s not nearly enough.
Insurance: Necessary but Not Sufficient
Liability insurance is the most basic level of asset protection for real estate. However, many investors believe that insurance is enough to keep them safe in most ordinary circumstances. It is not.
Insurance policies can be extremely helpful in certain situations, but they tend to have major blind spots. These policies typically cover negligence, but they usually do not cover matters such as fraud or breach of contract. If someone sues you for one of these, then your insurance policy will give you no protection at all.
Also, insurance companies do not want to pay you a dime more than they have to. If you file a claim with your insurance company, they will investigate the claim, and if they can find a way out of paying the claim – for instance, by arguing that the accident was your fault – then they will. This is simply the insurance companies’ business model, and why you shouldn’t rely on them alone.
Equity Stripping
One way to keep creditors from coming after your property is to make it less attractive to them.
A set of strategies known as equity stripping can allow you to do just this, by decreasing your equity in a piece of real estate property. In and of itself, equity stripping doesn’t protect your assets from creditors, but it can make it so that creditors will not go to quite such great lengths to obtain the assets. The prizes are less juicy, and less worth the effort for creditors.
There are a few ways of doing this. One is to place the property title under the ownership of your spouse. In California, all marital property is communal between spouses, unless both agree formally that a certain item is the separate property of one partner.
This can be a very effective way of protecting your assets from creditors, if done properly. It also bets a lot on the stability of your marriage. If you end up getting a divorce, and the asset is in your spouse’s name, then they will probably be able to keep it.
So, be careful!
Another way to equity strip is to place liens against your own property. Earlier liens tend to take precedence over later ones, so if you place liens on your property before you are sued, then these liens will come before any which your creditor can place… at least, generally speaking.
This strategy, too, has its drawbacks. Taking out liens can place you in significant debt.
Note: equity stripping for the purpose of asset protection should not be confused with equity stripping as a predatory lending practice on homeowners facing foreclosure – the two are very different practices, in entirely different contexts.
There is a lot more which could be said about equity stripping, but when done properly, it can be very effective.
Financial Instruments – Trusts, LLCs, and the Like
Don’t Own Property in Your Name!
One of the most powerful steps you can take to protect your assets is to take your property out of your own name and to place it into a financial instrument. There are a several types of financial instruments which can come into play here, but if used properly, they can be one of the best steps you can possibly take to protect your real estate assets.
Trusts
Many people think of trusts as an estate planning tool, but they can be just as useful for asset protection.
Ordinarily, when you place assets into a trust for estate planning purposes, you can take them back out at any time. This is known as a revocable trust. However, you can also create an irrevocable trust, by which you surrender your assets entirely to the control of your trustee.
It’s easy to see why most people don’t create irrevocable trusts, but they have their uses: in particular, they can be useful asset protection tools. Once you have placed real estate assets within an irrevocable trust, they are outside of your ownership, and this makes them much harder for creditors to obtain.
Irrevocable trusts don’t work everywhere, but we’ll get to that in a bit.
Limited Liability Companies
A common strategy for real estate investors is to place assets into a Limited Liability Company, or LLC for short. Creating an LLC is not terribly hard, and you will be able to retain control of the real estate within the LLC, just as you would if you owned it in your own name.
If you plan carefully, an LLC can go a long way in protecting your assets from a lawsuit.
LLCs, like corporations, are based on the theory of limited liability, which is just what it sounds like: if someone sues your LLC, then they can only recover the assets within the LLC itself. They will not be able to recover any of your personal assets… so long as you have handled your finances properly, and not mixed personal and LLC assets.
You can go a step further, and put your real estate properties in different LLCs. This will protect your other properties from being affected if one is sued.
Of course, LLCs are also limited in the scope of what they can protect: even if they shield your personal property and that in your other LLCs, you still stand to lose any assets within the LLC itself.
That said, there’s more to LLCs (and, for that matter, trusts) than just limited liability. The jurisdiction matters a lot. And this is where asset protection really comes into play…
Offshoring
Just because your real estate is located in California doesn’t mean that the trust or LLC which holds them has to be located in California.
In fact, you can often maximize your asset protection benefits by moving your assets to another state, or even outside the country.
We’ve written a bit about offshoring in the past, and we encourage you to read our other articles on the topic if you want to learn more. The basic rundown is that different jurisdictions have wildly different laws regarding asset protection. While some, such as California, are hostile to real estate investors (and others) wishing to protect their assets, other jurisdictions are significantly less so.
If you want to move assets to another state, then we typically recommend Nevada. It is one of a few states in the nation that have laws designed to be friendly to asset protection, both for trusts and for LLCs, and the closest and most accessible state to California with such laws.
If you want to move your assets offshore, then we typically recommend the Cook Islands (for a trust) and Nevis (for an LLC). Both are small islands nations, but both have sophisticated legal systems, and both have designed their laws so as to be havens for foreign asset protection.
Moving assets offshore is legal, so long as you pay all relevant taxes. (Some island nations have a reputation as “tax havens,” but this is a separate matter from asset protection involving private creditors.) There are a few expenses associate with offshoring, too, and as you can probably guess, moving your assets to the Cook Islands or Nevis is much costlier than moving them to another state.
It al depends on two factors: the value of your assets and your risk level. The more you own in real estate, and the higher a risk you face, the more it makes sense to go offshore. For smaller investors with relatively low-risk investments, staying within the United States is probably the best plan.
An Individualized Plan
So far, we’ve given you an overview of many of the major asset protection strategies for real estate investors… but each investor has a unique situation. The best asset protection strategies are personalized, and a legal expert can help you design a plan that meets your specific needs.
It is also important to begin planning immediately: if you wait until you are actually sued to begin taking steps to protect your assets, then you can get in trouble for fraudulent transfer. In asset protection, the rule is always the sooner the better.
If you want to learn more about how to build an asset protection plan that works for you, please contact our firm today to schedule a free consultation. We have a diverse range of experience in crafting comprehensive asset protection plans for real estate investors of all shapes and sizes, and we will be happy to hear from you.