Tips & Tricks From an Attorney: Here’s How I’d Protect My Real Estate Assets

Tips & Tricks From an Attorney: Here’s How I’d Protect My Real Estate Assets



Business Management

[Editor’s note: The following is meant for informational purposes and is not legal advice. For information pertaining to your specific legal situation, please be sure to consult your attorney.]

Real estate asset protection is a favorite strategy used by rich real estate investors. The rich don’t take the same risks you do; they use the law to their maximum advantage. It’s not sleazy, it’s using the rules available to your maximum advantage. The most underutilized tool is an effective contract. Below, I’ll show you one little used trick to create maximum leverage in a lawsuit—and the most effective way to protect yourself should one ever result.

A highly effective tool that many don’t use is a contract with terms that favor you when a deal goes sideways and litigation could result. We don’t want litigation to actually happen because it is expensive—what we do want is a contract that gives us huge amounts of leverage to get the settlement we want quickly.

To protect yourself from lawsuit—and to protect yourself even in the event you need to sue someone (YES, suing someone does put you at risk)—you will want to use an LLC. The rich use LLCs.

Have the Remedy in the Contract

If the remedy is spelled out in the document, then you don’t have to rely on complicated legal matters for your remedy. If you’re buying real estate and the deal goes bad, do you want the property or do you want money? If you want the property, you need a provision for “specific performance.” Otherwise, what you’re left with is a suit for “damages” and money. The bad part about “damages” is you have to prove how much you have been harmed.

Unless you were getting a killing on the property compared to the comps in the area, how do you show how much money losing the deal cost you? The solution to this problem is known as “liquidated damages.” This is a clause that specifically states the amount of damages in the case of breach of the contract, i.e. the other side backs out.

For example, the contract could say if the seller refuses to execute the sale after the buyer obtains financing for the deal, then the seller is liable for a liquidated damages amount of $40,000. Note that this should be one sided to your favor so that only the buyer has these rights. This gives you leverage over the seller since they know they have much to lose instead of having hope of low damages being determined by the court.

Some people say the seller will balk at this type of clause—and they likely will. But you can counter by asking them, “Do you have any intention in backing out of this deal after I put in thousands of dollars’ worth of man hours and hard cash? No? Well, this clause is to ensure that you won’t and gives me confidence to know you’re serious about moving forward.” At the very least, this opens the door to a negotiation about what amount of liquidated damages are agreeable between you two. If litigation does result, your future attorney will kiss you.

When a Deal Goes Bad, You Should Be Prepared for the Lawsuit

Even if you don’t believe anyone would ever sue you for any reason and you are 100 percent sure, you will still want an LLC for protection. You may not be sued, but you will need to sue someone. When you sue someone else, you put yourself at risk. In the United States, the prevailing party, which may be the other party, can be awarded attorney fees. You would be surprised to find out that the damages could be only $1, but since the other side prevailed, they get $30,000 in attorney fees. If you sue someone, it could come back to bite you.

How Does the LLC Help?

The LLC acts as the plaintiff to the lawsuit instead of you personally. Since the LLC is the plaintiff, if there is an award for attorney fees or other damages, then they can only look to the LLC. The cost to file a new LLC is MUCH cheaper than the cost of paying off a judgment. Also, remember that if a judgment is ever filed against you, then it appears on your credit report, harming your score. Since we are in the borrowing business to leverage our hard dollars with those from the bank, this hurts our bottom line.

What Does This Mean Practically?

You should never buy a property, hire a contractor, or talk to anyone—your operating shell LLC should. The operating shell LLC is an LLC that has no assets and is the face of your business dealings.

You can only sue someone that you interact with, either in contract or communication. So, if you want to insulate yourself from lawsuits, then you have to act through a business entity. How do you do this? Create an LLC that owns little to no assets and acts as a shell. Since that LLC made all of the communications and entered into the contracts, then that is the only entity that they can come after. So when a lawsuit happens, what do we care? Our worst case scenario is that we wind up the LLC (i.e. destroy it) and start a new one. It’s not a sketchy thing to do, it’s using the laws that exist to our advantage.

The elephant in the room usually regards when the LLC isn’t effective and the court says  you have “pierced the corporate veil.” I don’t care about piercing the corporate veil. I anticipate that as a possibility when I use an operating shell LLC. Even if the court were to “pierce the veil” of my operating shell LLC, the worst case scenarios is that they can attack me personally. Guess what? I don’t own anything; my separate asset holding LLC does.

Rich people don’t own assets, and their operating shell LLCs don’t own assets, either. Under this type of legal strategy, even if they are able to pull every legal trick, the worst thing that someone can do is harm a credit score. The reality is that nobody spends the cash to hurt you when they know they’re not getting anything in return; lawsuits are a business.

We’re republishing this article to help out our newer readers.

Investors: How do YOU protect your assets?

Leave a comment below, and let’s talk!

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About Author

  1. Pro

    Wow this is a VERY informative article.
    Mr. Smith, you should lurk on the question and answer forums – you would not believe some of the inaccurate advice that is offered.

  2. Denis MonahanPro

    “Even if the court were to “pierce the veil” of my operating shell LLC, the worst case scenarios is that they can attack me personally. Guess what? I don’t own anything; my separate asset holding LLC does”.

    And who owns the separate asset holding LLC?

    It is a somewhat common misconception that LLCs provide what I call “downstream” liability protection, i.e., if someone gets a judgment against you personally that they cannot reach assets that are in a LLC that you own or that is in your revocable living trust. If you own the LLC , it is just like any other asset. If you owned 1,000 shares of Apple or any company, and someone got a judgment against you they could reach those shares of stock. They would not get to Apple’s bank account, but they could force the sale of that stock and get the proceeds. They can do the same thing with an LLC that you own. There are other complexities such as “charging orders” etc. beyond the scope of my reply. LLCs, if properly formed and properly maintained, can provide what I call “upstream” liability protection, i.e., a judgment against that LLC can reach the assets owned by that LLC but cannot reach up hirer and get the other assets of the owner of the LLC.

    At to how many LLCs? The “Goldlocks principle” appplies. Not too many and not too few. If you have invesest properties and do fix and flips, have your investment properties in different LLCs than you fix and flipper – which is an operating entity taxed at ordinary income rates. If you have other members, do not mix members in the same LLC. If you have a higher risk asset (.e.g. a multi-unit apt in lower economic area, it gets its own LLC. Next, you diversify your real estate assets just like any other assets. How much do do what to have at risk in any one entity? Five $50k houses with 70% mortgages equals one $175K house you own free and clear. An don’t forget insurance.

    Be careful about “self-medicating” based on what you read on the Internet.

  3. I’d like to see a flow through example of buying a property and accepting rent. Which entity does what and how does the property move between them. Maybe this is a partial bookkeeping / tax question, but it’s also a legal question.

    If the shell LLC writes the offer (and can get a loan), how does the property then transfer to the asset holding LLC without triggering the “Due on sale” clause.

    If the shell company is collecting rent, is it then paying it to the asset holding company or does it hold the rent? Seems the asset holding LLC gets all the depreciation, which I guess rolls up to the shell LLC to offset the rental income, but then, is the shell LLC holding the rents for the year?

  4. Here is what I currently have:
    LLC 1
    LLC 2
    LLC 3
    LLC 4

    Management LLC owns 100% of LLC 1-4.
    I own 100% of the Management Company.
    The leases are through the separate LLCs. If you live in LLC 2 your lease is with LLC 2.
    It will be on Management LLCs letter head but the landlord you are making the contract with is LLC 2.
    Management LLC is the only one with a bank account and is allowed to do all banking for the other LLCs.
    Also the other LLCs all have their own mortgages…eventually these will be non-recourse.

    So if a tenant sues me then they sue the LLC that they live in. If it’s for a ton of money I can bankrupt that LLC and they would basically get the equity in the house. But they can’t get any assets being held by the Management LLC. Is this correct Scott?

    If so how does a series LLC give you any more protection?
    Also you might want to explain how a charging works. Most people have probably never heard of one.

    • Pro

      I follow you exactly and would love to hear Scott’s reply to your scenario.

  5. Pro

    Curious how a lease would be written with an operating LLC that doesn’t own the property ? Doesn’t the lease have to be with the owner?

  6. Pro

    It isn’t clear to me who is the member of the operating shell LLC…? Who is the member of the asset holding LLC? Is one the member of the other?

    • There are two types of mortgages. Residential and Commercial. Residential is for both a person looking at buying a home or a person looking to purchase an investment property. This type of loan will not be allowed to be done in an LLC and it must be done in your name which will hurt your DTI ratio and it will be reported on your personal credit report. We only have 1 more of these left and the interest rate is 4.75% with a 25% down payment. For the record that property is deeded in an LLC.

      Now is where the real fun comes in. The commercial loan is for investors. These loans are only done using a cooperate entity like an LLC. US Bank has the best commercial loan department for properties that are 4 family or below because most banks will not do a commercial loan unless it’s 5 units or more. US Bank will still make you use a DTI ratio but it’s a little bit different than normal and it’s much easier to meet than residential banks.

      When the properties get above 5 units you can start to use other commercial banks. I have a few small ones here in town that I use that lend locally. Once the loan amounts get above $1MM and $2MM you can start to use fannie and freddie to do the commercial deals.

      Thought is go get a commercial loan…you will need to talk to the business banker or a commercial loan NOT just a normal banker. Ask for those two.

  7. Pro

    I have several concerns here. First when there is a lawsuit the winner does not automatically get lawyers fees. There are 2 rules, the American Rule which says you only get lawyer fees if it is in a contract, or if a statute provides for it. The second is the English rule that says the winner gets his lawyer fees paid by the loser. It is my understanding that the American rule is more common in states than the English rule.
    Next I am concerned about putting all of my assets into an LLC. If I put my house in an LLC and I don’t pay fair market rent that fact can be used to pierce the veil. If I pay buy my groceries out of the LLC then they can pierce the corporate veil. Even if you get your personal assets into an LLC and it doesn’t pierced and they only get a charging order, you can never take cash out of the LLC again until all the money from the judgement is paid in full. So how have you helped yourself? If you buy houses and collect rent through shell LLCs and leave no money in them they are under capitalized and the veil can be pierced. If you think you can hide assets using a land trust or any other scheme how do you answer questions in a deposition where they ask you to list every entity you have an ownership in, or that pays you any income? Any entity you have created in the last 5 years, any entity you list on your income tax forms, etc. It is prison time if you lie on those things. LLcs are a very good idea when you operate them as a true business and not as a scam. There are also some great exemptions to protect your personal home if it is your name that is not available if it is in an LLC. There are even better protections if you are married and own as tenants by the entireties. You lose that protection if the ownership is in an LLC. LLCs are great, but they are not the magic pill being portrayed here. Series LLCs are nice in states that allow them. Nevada has the reputation of being the place you want to file them, but Texas may have a good one also, I have just not seen it as popular with those I deal with. Saying you just collapse an LLC sounds easy, it is not. Have one pushed into a bankruptcy and watch a Trustee go through the layers like hot butter If the LLC owns several properties but gives every penny to another LLC you will see the Trustee pull the next LLC in. Someone must attend the debtor hearings for an LLC in a bankruptcy, and you should see the questions they must answer. These things are not as simple as what you are being sold. The guy who signed the legal contract is the guy who gets who deposed. If you are the only member that guy is you. Do you think you can not go to one of those by retiring from the LLC? Guess again.
    Most of these strategies are pretty complex for someone starting out. Unless you are already rich I would start with a single LLC for the first few properties. Get a good book on how LLCs must operate so you observe all of the corporate formalities.

  8. Hi there! I love this article. A quick question regarding personal assets… what all is in your asset holding LLC? When you say you have nothing, does this also include paper assets? I know Robert Kiyosaki said his house/cars etc. are in an LLC. Just curious about other things as well.

    Additionally, if your operating LLC (the one that enters into leases and hires contractors) is to be sued, and then they pierce the veil and come after you, and then realize you don’t own anything, but they still win a judgment, how does that all work?

    Lastly, where does an umbrella policy come into play with all of this? Will it cover your LLCs as well if you put it under your name or is it smarter to just have that policy and everything under your name?

  9. Interesting article and responses.

    As an attorney who has repeatedly “pierced the veil,” in the corporate/LLC realm, and then pursued various other assets (to include other interests in other entities), I find it troubling that LLCs are being touted in this fashion. An empty LLC will be deemed undercapitalized (a fatal flaw), and therefore an alter ego of the owner. Thus, a judgment against a defunct LLC can, and likely will, be enforced against interests held in other entities.

    The term charging order that has been used several times in the comments here is largely irrelevant to the concept being touted. Indeed, the original intent of a charging order was to protect business partners for the mistakes of the other partners. In other words, it was intended to prohibit companies from being bankrupted when one partner did something culpable, by limiting the applicability of a judgment to that particular partner’s draws/distributions from the entity, and not permitting the judgment to attach to other property held commonly by the entity. Arguably, and in at least one court case I’m aware of (potentially more), a court held that charging order protection doesn’t apply to single member entities, because clearly there are no other partners to protect. I’m repeatedly using the word partners as opposed to members (members is what LLC owners are called), because charging orders were intended to help members of partnerships, not LLCs, although the protection has been extended in most states.

    Now, for the good news (finally right?)! Capitalization, the issue that we’re talking about as a potential reason that someone could “pierce the veil,” is a rather simple one. The entity needs to have sufficient funds and/or assets to carry on normal operations and survive routine liability. Better yet, an entity can be collateralized in other ways if you don’t have a lot of funds and/or assets to put into it, simply by purchasing appropriate insurance for the liabilities inherent to its own operations.

    True protection through the use of various entities/structures/trusts is very possible, and EXTREMELY advisable, but do so with advice of competent counsel who is familiar with your goals and operations. There are costs to doing business, and the cost of competent counsel (yes I know this is a shameless plug coming from an attorney!) will be a small pittance compared to the cost of defending your first dip into the wonderful world of litigation.

    Best of luck and look forward to connecting with some of you!

This content was originally published here.

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