So, you’ve found the perfect investment property. You know all about IDEAL Investing and why you should be buying one to help secure your financial future and support a comfortable retirement. What if your tenant wants to take it all away with a lawsuit? Have you thought about asset protection?
“What do you mean by asset protection? I already have insurance, what else do I need?” – Covered Capitalist
Mr. Capitalist, you are right in the need to have insurance. Liability insurance is the first line of defense for asset protection. Make sure your insurance agent has all of the information about that property and that you are purchasing it as a rental property. The liability limits your agent sets for you should at least cover your current net worth, after your most recent real estate purchase. An umbrella liability policy for your new property–and any other you may have–is only $200-300 a year for 1 million worth of coverage. Be sure to call your insurance agent and get this umbrella policy in place.
“I have some cash in the bank to cover me when vacancies strike. What other asset protection is there?” – Affluent Accumulator
After you have the insurance route covered, another type of asset protection is a business entity that protects you from lawsuits due to injuries or other issues with the property. You may have heard the warnings about taking ownership of investment real estate under your own name. When you own the property as a “sole proprietor”, this means that any lawsuits against the property are actually against you personally. A litigant could come after your personal home, your cars, your grandma’s pearls, or anything else that belongs to you. This could certainly turn that $20K down payment for your first investment property into a total loss, and then some.
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How Do I Protect Myself With a Business Entity?
Purchasing your investment property under a separate entity, such as an Limited Liability Company (LLC) or corporation, legally detaches yourself from the property. LLCs and corporations are regarded as separate entities. This means that if you place the investment property within the LLC or corporation, you still control the asset, but you don’t personally own the property. Sure, you are the owner of the company, but at least if the company is sued, no one can go after your personal assets. This protection is what is legally known as a “corporate veil.”
CAUTION: If you, as the manager of the entity, has committed fraud, misrepresentation, deceit, etc., your personal assets could still become subject to liability. When your personal assets are targeted, this is called “piercing the veil.” Shoddy bookkeeping, the use of company assets to pay for personal expenses, and incorrect entity formation could negatively impact you. Please make sure to consult an attorney to ensure your LLC or corporation is set up correctly for your legal protection needs. It’s also important to discuss the correct business entity with your attorney since you could pay excessive accounting and formation fees if you create a company that doesn’t align with your objectives.