By Dr. Peter Kim of Passive Income MD, WCI Network Partner
Owning rental properties is an excellent tool for building wealth, passive income, and ultimately achieving financial freedom (if that’s your goal). Of course, as much as I love it, it’s not without its risks.
One of the major risks comes from liability.
As doctors and high-income professionals, we’re well aware of lawsuits and the risk that comes with liability. At times, it might even feel like we have targets on our backs. So we need to protect ourselves.
This carries over into the world of real estate investing. For example, if a tenant or vendor were to trip and get an injury while on your property, you could be looking at a hefty lawsuit. As an owner, you have to anticipate this could happen.
Enter the world of asset protection. In real estate ownership terms, asset protection is a vital way to make sure you won’t lose your property, capital, or even personal savings in the event of a lawsuit (or other calamities).
There are quite a few different methods that many real estate investors use. Today, we’ll be looking at four of the best and most common ways to protect and safeguard your properties and other assets.
Insurance is by far the most common way to protect your assets, and it works pretty well. This doesn’t change someone’s ability to sue you, but it does cover you in that event.
The great thing about insurance is that it’s simple and easy. After all, as owners, we’re required to have insurance on our properties anyway. Just increasing the coverage to adequate limits is a great start.
You’ll also likely want to add umbrella insurance as well. Umbrella insurance is insurance that covers in excess of your primary policy. My opinion is that we should all have personal umbrella policies, but when it comes to a rental portfolio, we should all have these as well. This is surprisingly cheap–and well worth every penny.
The only foreseeable issue with insurance is that if the lawsuit is large enough, it could exceed your coverage and leave you on the hook for the difference.
Before adding or changing insurance, it’s absolutely crucial to compare coverages and get the in-depth details on any exclusions that could leave you high and dry when you need it the most. Pay very close attention to the fine print of your policy and make the most educated decision possible.
Anonymity is another great level of protection. Many investors will place their properties into entities that do not list your personal name publicly. That way if there’s an issue, it makes it difficult for people to easily identify who owns the property.
Let’s face it, as a doctor with a large number of personal assets, you look a lot juicier to a potential lawsuit.
I’ll talk about LLCs below, but another method is to use an Anonymous Land Trust, which is essentially made up of three parts: a grantor, a trustee, and a beneficiary.
By doing this, the bank (or other institution) acts as a temporary trustee–only long enough to file the paperwork. After that, you are listed as the sole trustee.
This can be very beneficial because if someone decides to sue you, their lawyers will find it extremely difficult to find your name in association with the trust. This is made even more difficult if you were to use this trust to create an LLC (which we’ll get to in just a moment).
Basically, an anonymous trust leaves your name out of all the paperwork involved, making it virtually impossible for people to find you in connection with your property. Of course, not knowing who to sue makes a lawsuit very tricky.
The least expensive of all methods on this list, debt provides quite a bit of built-in asset protection. After all, if you don’t have a lot of equity, there isn’t much for a potential lawsuit to take away.
The basic method is to continually pull equity out of your properties and use it to invest in other properties or ventures. This is effective for two big reasons. First, the money you take out of your equity is a kind of loan, used to purchase another property (or whatever it might be). This “loan” is not subject to taxes, which is a significant advantage.
The second reason is that, of course, without much equity available, you can make sure that you never have much to “lose.” This is a great way to minimize risk, but it does require quite a bit of active strategizing.
I’ve written a much longer post on just this subject, but in short, the question of whether or not to put your properties into an LLC depends on quite a few factors.
Obviously, the main advantage is that it limits your personal liability. For the topic of this post, this is a pretty big advantage.
Plus, if you take the Anonymous Land Trust method I mentioned earlier, an LLC can add an even greater layer of protection. Basically, if you name your LLC as the trustee, your personal name won’t be listed anywhere in the paperwork of the trust or property ownership documentation.
The downside is that establishing and maintaining an LLC isn’t necessarily the easiest or cheapest route. There are also potential loopholes that could result in less protection than you might think.
If this sounds like a good option for you, make sure to consult with a legal professional. That way, you’ll make sure to avoid any potentially costly errors and get set up in the best way possible.
Ultimately, when it comes to asset protection, the most important thing is to find the right strategy for your situation.
This is one of those areas where you hope you never have to make full use of the protections you put in place, but you’ll be happy you did if anything were to happen. After an incident occurs, it’s too late at that point.
You’ve worked so hard to get where you’re at, and you’re doing your best to create the ideal life for you and your families. Take this seriously, as it is one thing that can quickly damage what you’ve built.
Mitigating risk is a huge factor in successful real estate investing, and it applies to every aspect of the purchasing process–even when you already own a property. Taking the right steps ahead of time can save you from a world of headaches down the road.
Did he miss anything? What other strategies do you use to safeguard your properties and other assets? Comment below!