Owning property by definition makes you vulnerable to risk. Landlords have traditionally faced exposure from incidents like slip and fall accidents suffered by tenants, guests, or passersby, under-insured workmen, who while on your property, become injured during the course of their job, and animals that exhibit their hostility. However, the old liability minefield has broadened to include some new sources of risk.
“Landlords are more liable because of the bad economy,” says John Walker, asset protection planning attorney, of counsel to Duke Law Firm. “In addition to the sub-prime problem, you have people who had a job, but don’t have one now, who may be looking for someone to take money from. Then there is the issue of occupancy rates dropping. This creates a problem because real estate investment is a cash flow business. The Mom and Pop owners don’t have deep pockets. A large number of vacancies can lead to bankruptcy.”
That’s why John firmly believes that every landlord, mo matter how many rental units they have, needs to create a protective barrier around their property through asset protection planning. This is an area of legal practice that was developed during the 1970s, and is based on five areas of the law:
- Estate planning
- Corporate law/business planning
John says that one way to look at it is planning to help you avoid the high toll that litigation can have on your assets. “The idea is to protect assets so that if you’re attacked, after the attack is over, you still have something left.” Asset protection planning makes use of exemptions in both common and statutory law so that the landlord owns their assets. This accomplished by taking assets that are exempt from a creditor’s grasp, and putting them into business entities that have protection built in so that the landlord becomes insulated from litigation.
However, says John, despite the claims of some, asset protection planning doesn’t make a landlord bullet proof. “Laws are complex and changing all the time. What we set up three years ago we have to go back and revisit. Also, creditors’ lawyers are aggressive and they will look to undo what has been set up. Courts don’t like it [the attitude that you’re bullet proof]. You will pay your debts. You’re not supposed to try and get out of it. When you injure someone, you must make them whole. If you believe you’re bullet proof, the court may deal harshly with you.”
Instead of the false bravado, landlords should look at asset protection planning as a way to dissuade a lawsuit. The established business entity should make it so difficult to sue, that the creditors would rather settle than pursue litigation.
When it comes to the question of whether or not there is any circumstance under which landlords should leave property in their own names, John answered with a resounding, “No!” He explained his answer this way, “Landlords live in a hostile environment. You can compare it to a snowstorm with snow blowing all around. We need to go outside once and a while, but if we go out in a tee shirt and shorts, we won’t last very long. So we need to have layers of protective clothing, with each layer serving a different function. The layers are attacked, but we’re safe. Creating a business entity is like having layers of protective clothing.”
So what options are available in terms of business entities, and how do you know which one is right for you? This area of the law, according to John, is called entity selection and it is part corporate law and part business planning. The idea is to get the protection of a corporation and the tax advantages of a partnership.
While the corporation and the partnership are options, they aren’t really used as much as they were in the past. The two types of entities that are most common are the limited liability partnership (LLP) and the limited liability company (LLC).
The LLP will give you the liability protection of a corporation, meaning that creditors cannot come straight to the landlord. There is a protective barrier between the landlord and the creditors because the LLP makes the business separate from the owner. However, the LLC has the added advantage of being what John calls a “tax chameleon”. If there are two or more owners, then they can choose how the LLC will be taxed, which means getting the advantageous tax status of a partnership.
Of course, all of this protection doesn’t come without a few drawbacks. It is expensive to set up a business entity. The fact that it is separate from the owner means separate bank accounts, and separate tax returns, which translates into additional record keeping and higher bookkeeping costs. Additionally, there are some states that charge filing fees and annual fees to continue to do business.
But as John notes, you have to weigh these additional costs against the benefits. And in the current volatile environment that landlords find themselves in, you can’t put a price on protection.
John Walker is an asset protection planning attorney with Duke Law Firm