We generally see two types of landlords: investors who desire to diversify their assets with real estate by owning several rental properties and investors who moved and opted to rent their old home rather than sell it. Regardless of how you entered into real estate, liability exposure is still a concern.
As a landlord, you can be held responsible for injuries incurred on the rented premises, injuries or damage that are caused by animals that your tenants own, and even unlawful conduct of your tenants, among many other perils. In contrast, your stock investments generally do not expose you to such liability claims. No one is going to sue you for slipping and falling at a restaurant if you own McDonald’s stock. But if someone were to slip and fall on your rental property, your assets—like your McDonald’s stock—could be at risk.
While most financial advisers are not lawyers, the adviser is still a good place to start when you are concerned about your liability, as they often understand how your other assets are titled, where they are held, and what might be at risk. Generally, individual retirement accounts, 401(k)s, and other types of tax-deferred retirement accounts can shield your assets in case of a lawsuit.
If the majority of your assets are in retirement accounts, it may be more efficient to protect yourself from excess liability claims with an umbrella policy, which is a specialized policy to help cover costs that go above your standard insurance policy’s liability limits. This can be a cost-effective way to minimize the risk that comes with owning a rental property. We often see umbrella policies used by younger investors who may have married and opted to rent one spouse’s former home. If you decide to cover your liability with an umbrella policy, you may also consider having the spouse with fewer assets hold the title in his or her name only while the other spouse holds that title to the family home.
Now, if you own multiple rental properties, we often recommend using a limited liability company (LLC) to hold your real estate. An LLC is also ideal for those investors who own their own business or have brokerage accounts with other investments. The more assets an investor and his family own, the more important it becomes to protect against this liability.
When you establish an LLC, you can effectively limit your liability to the assets owned within the LLC. Your worst-case scenario is that the LLC is sued and forced to declare bankruptcy, and you lose the rental property. Your other investments, retirement, wages, home, and cars are all protected. Furthermore, with multiple rental properties, your lawyer may recommend separate LLCs for each property to protect your other properties from a lawsuit.
However, before you create an LLC for your rental property, it would be prudent to discuss your plans with your financial adviser and your lawyer. You need to be aware of the ongoing costs and annual filings for an LLC, and your current mortgage on the property may prohibit you from transferring the title. Even with the potential drawbacks, an LLC is still one of the best ways to protect your personal assets from a lawsuit stemming from your rental properties.
If you have questions regarding your real estate holdings, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
