What do we mean when we say “Asset Protection Planning”? To answer that, we first need to understand to what “assets” we are actually referring.
Over the course of your life, you will (hopefully) amass what we call “assets” (aka stuff worth money). Some of those assets might be growth or income-producing assets, such as stocks or real estate. While others may just be stuff that continually loses value, like a car or IKEA furniture. You also may just have some money (aka cash) in the bank sitting there for a rainy day.
One of almost everyone's life goals is to accumulate enough wealth (in the form of these assets) in order to eventually retire (or do whatever makes us happy…which could also be to continue working, if you like working).
Now, when you are young and don’t have much to your name, you don’t spend a lot of time worrying about “asset protection.” But as you get older and start to accumulate some assets (and also realize how damn hard they are to accumulate), you have to start protecting those assets from being taken away from you!
So, Asset Protection is essentially “the practice of avoiding having your assets taken away from you.” Pretty simple!
How can my assets be taken away from me?
There are a couple of primary ways you can lose your assets…1) is by making really poor investment decisions where you lose money instead of making it…boo, and 2) by getting sued and losing. This post is mostly about being prepared for the latter.
As related to real estate
Here is the basic scenario you want to avoid. You own all your rental property in your personal name, along with your other assets like your house, your stocks, your cash, etc. Well, if one of your tenants sues you (and wins), they would potentially have access to ALL of the assets you have in your name…that’s no bueno!
Now, your insurance on the property might cover you up to a point, but if it’s a large judgment, the claimant will try to get the rest of the money from any accessible source it can find. And if you have ALL your assets lumped together under your name…well that means they are ALL accessible.
Other ways to lose your assets
You can get sued for anything it seems, and lawsuits are a primary way we can lose our assets. Here are two more areas in which you may be susceptible to lawsuits.
In your personal life…
Largely this would include something “bad” happening at your residence, like your dog mauling the neighbor's kid. Or while driving your car, you hit and maim someone. Beyond that, you could perhaps get sued for slander or something weird like that.
In your business life…
If you make your living as a freelancer, independent contractor, or own any kind of business, you are always more open to lawsuits. This could be anything like you causing some accident while doing a freelance gig, or committing professional malpractice in some way.
Yikes! OK, so how do I protect my assets in regards to real estate investment risk?
Disclaimer: I am not an attorney. All of this information I gained by research, speaking to attorneys, and then by implementing a strategy for myself. It’s always best to run your strategy by a licensed attorney to verify its viability.
How do we avoid this risk and attain asset protection? You set up “Entities” to hold, and more specifically “silo” your assets. What kind of entity did you ask? Well, for real estate, it usually comes in the form of an LLC (Limited Liability Company).
See…it's right in the name…”limited liability.” It limits your personal liability! (Actually, a good ol’ “corporation or INC” also limits your liability…but it’s not as good of a name I guess)
(If you want to see how to set up an LLC using a service I like, IncFile, take a look at this Youtube video I made)
When an LLC owns the real estate asset, and the tenant pays the LLC their rent, then they are in a business relationship with the LLC (not you personally) and they would sue the LLC (not you personally).
They can still get a judgment of course, but the amount of money they could access would be limited to the value of assets the LLC holds…which would be the equity in said house. Now, if you have multiple houses in an LLC, then the equity of ALL the properties in the LLC would potentially be accessible.
That’s basically it in a nutshell! You put your real estate in an LLC, so that you can protect your personal assets from tenant lawsuits.
What else do I need to know about real estate LLCs and asset protection?
Good question. While my nutshell statement is true, there are a few more things you might want to consider when deciding how to develop your asset protection plan.
The main issue (and potential deterrent) of putting your real estate in an LLC, is that they cost money to set up and maintain and require some annual maintenance. This comes in form of state annual filings and tax payments you have to make on the LLC.
(The reason the fees are a concern is that they chip away at the return on your real estate investments. That's probably obvious, but worth clarifying!)
You are probably now wondering exactly what those annual filings and costs are? Well, it all depends on what state you live in…so that is something you have to figure out when you are deciding if an LLC is worth it.
Now, with all that in mind…
Here is what you should look at when deciding if this asset protection strategy is right for you.
-How much do you have in personal assets that you could lose? If your only major asset is your rental property, then it’s all you can lose anyway, right? In that case, why take on the extra expenses?
-How many properties do you have? If you only have one or two, you may do better (expense-wise) protecting your assets another way.
-What states are the properties in, and what state do you live in? If they are not the same, your entity costs could go up even more because you may need to register the entity in the state of the property, as well as in your own state, and pay double tax.
-If you have some significant assets, are they mostly in retirement accounts like IRAs or 401Ks? If so, those assets would not be accessible by a lawsuit, so you don’t have to worry about those.
-Or if much of your other “assets” are tied up in the equity of your home, depending on the homestead laws of your state, they keep you protected from lawsuits by default.
For example, since I live in FL I have unlimited equity protected from lawsuits if my primary home is registered as my homestead. But for those in CA, only 75K of home equity is protected from lawsuits. (That said, I can’t say if the judgment could “wait” for you to sell your house or for how long they can “wait.”)
Other ways you can protect your assets using umbrella insurance!
If after asking the above questions you decide that you are not ready to start setting up entities, the next best option is umbrella insurance. Umbrella insurance is essentially lawsuit insurance (excess liability coverage) for your personal life!
Actually, this article is more specifically about asset protection as it relates to lawsuits from real estate, but you can get sued in your personal life too, which can put your assets at risk in just the same way. So, umbrella insurance can help with that as well.
One of the main ways you can get sued personally is by getting in a car accident and seriously injuring someone. You do have auto insurance coverage for this, but if you get a judgment that is higher than your coverage, they go after your assets.
Umbrella insurance provides coverage in that case, above the limit your auto policy provides. So say your car insurance covers you for 250K, but you also have an umbrella policy for 2mil..then you are covered up to 2mil. And fyi…you must specifically attach your vehicle to your umbrella policy.
Furthermore, umbrella can do the same for your rental properties. Like with your car, you list all the properties on the umbrella policy. If you get sued, the policy covers you after your rental property coverage gets maxed out.
Couple of things to note, however. The umbrella policy will require you to have the highest limits available on your primary auto and rental policies…so you may have to augment that existing coverage (and pay more there).
Also, some umbrella policies will limit the number of rental properties they will cover. So once your property portfolio grows, you may be forced into the LLC approach.
Asset protection from your business activities
I figure I may as well round the bases and also mention that you should be concerned about asset protection if you work as an independent contractor, freelancer, or unincorporated business.
The way you would protect your assets from any of your business activities would be to create an entity for your business. You might also use an LLC or even an Inc. I personally have an “S-Corp” Inc.
When you have an entity for your business, just like for the business of your real estate, you “silo” that activity to be within the LLC. This way, if you get sued, it’s really your entity that gets sued.
But just like you have for your real estate, you should probably have some insurance coverage in place for your business activity, such as general liability and perhaps even professional liability.
Lastly, in addition to this protection, you can also build credit for your entity and pay less in taxes if you make it an s-corp. If you want to read more about the value and process of creating an entity for your business activity, check out my article on the topic:
Independent Contractor Taxes & How to Incorporate (to Save Money)
Ok, so if you are wondering what I do for asset protection….
I have real estate LLCs and personal umbrella insurance. Plus I also have insurance specifically for my consulting business, which is yet another entity (that one is an S-Corp).
While as of late my mini real estate empire has been reduced, because I have slowly been consolidating my equity to fewer (higher value) rentals in FL, below describes what I had going at my peak.
My situation ended up being somewhat complicated because I was living in California. CA requires you to register all out-of-state LLCs as foreign businesses operating in CA. That would have made the carrying costs even higher.
So what I did was to have an LLC in WY own (almost) all of my other out-of-state LLCs. That way, I only had to register the WY LLC in CA and pay the $800 minimum tax once.
You will see that I didn’t include TN in this, however, because in TN if your RE LLC is 100% family-owned, you can get an exemption from paying most annual tax. If it's owned by another LLC, you would have to pay the full tax, and it would have been a higher total. So, I just registered that one in CA as well.
Some additional resources
Asset protection can get pretty deep, especially as your portfolio grows. I learned a lot of the details of what I’m telling you through implementing my own strategy. But before that, I read a really good book on the topic.
Loopholes of Real Estate
by Garrett Sutton
I learned a lot from this book, and not just about asset protection. It covers myriad topics related to real estate.
I even booked a call with Garrett, and he helped make some adjustments to my plan!
Beyond that, please check out some of my other articles that will help you build assets!
Big Picture Investing: Why You Need to Get in the Game Now! (Short Version)
You Need to Do Your Personal Bookkeeping (Like a Business)…and You Hate It…Now What?!?
Renting vs Owning: Why You Need to Own the Real Estate You Live In (of Which You Will Be the World’s Best Renter!)