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The risks of owning real estate


Many people are diving into the real estate market every day. Whether it be a desire to supplement a salary with additional income, wanting to be the next short-term rental mogul, or to build generational wealth for your family, owning investment properties can produce big rewards, but also big problems. For these reasons, it's important to understand how to set up your property ownership in the most beneficial way to you as an owner.


The internet is saturated with various posts and articles with techniques for managing your investments and it can often be a daunting task to weed through masses of information and attempt to discern what is the best advice. Our goal here is to provide a concise and succinct summary of some of the best strategies. We hope the result will be a solid foundation and valuable starting point for the best ways to protect yourself as an owner and guarantee the best treatment of your assets.


As always, we are not lawyers or CPAs, so please consult with both your estate planner and tax professional about the implications of these changes for your specific situation.


Ownership Risks


While property is a valuable investment, there are some significant risks to ownership. One of the biggest potentials is lawsuits. Ranging from common slip and falls, to environmental contamination, owners can be easily exposed to legal judgments. Owners have also been successfully sued by victims of crimes - robberies, rape, and murder - that occur on their property based on the theory that the owner provided inadequate security.


Option 1 - Benefits of a Trust


There are many types of trusts, but the one most often utilized with real estate is a revocable living trust. The major benefit from holding property in a trust is that the property avoid probate upon the death of the owner. Probate is a court-supervised process for transferring assets to the beneficiaries listed in one's will. There are many advantages to avoiding probate - distribution of assets held in a living trust can be much faster than probate, assets in a living trust are more easily accessible to beneficiaries, and the cost of distributing assets in a living trust is often less than probate. (Note: There are also other ways to avoid probate - i.e. property held in joint tenancy with a right of survivorship automatically avoids probate regardless of living trust. Consult an estate planning attorney for more advice on probate matters.)


Option 2 - Benefits of an LLC


While there are some other options for creating a business entity for a real estate investment, LLCs are often the preferred method for investors, attorneys, and accountants. LLCs are fairly cheap and easy to form, retain complete limited liability for all members, and avoid the extra paperwork and tax filings required for corporations.


Some important considerations are necessary to successfully achieve all protections offered by forming an LLC: 1) properly file the LLC with your state and continue timely completion of any forms required to keep the LLC in good standing; 2) open a business bank account for the exclusive use of the LLC; 3) fully segregate all business and personal expenses; 4) maintain thorough bookkeeping and documentation for income and expenses of the LLC.


One LLC or Multiple LLCs?


If you own multiple properties, you are probably wondering if you can hold all properties under one LLC or if you need to create a new LLC for each additional property. For several reasons, it is generally advisable to have one LLC for each property.


First off, having a separate LLC for each property prevents spillover of liability from one property to another. An example of this would be suppose you have two properties worth $500,000 and they are owned by the same LLC. If a tenant is injured at property #1 and wins a $750,000 judgment, a lien can be placed on both properties (via the single LLC) for the entire $750,000 even though property #2 had nothing to do with the tenant's claim. If each property was in a separate LLC, the creditor could only place a lien on the property where the tenant was injured.


Additionally, many banks and lenders require separate LLCs for each property, so if you still have a mortgage, discussing this with your lender is very important. The lender does not want a problem at a separate property to jeopardize their security interest in the property they are financing.

Layering Protection - Using both an LLC and a Trust


Because both a trust and an LLC can provide significant benefits to a real estate investor, savvy investors typically rely on both of these to adequately protect themselves and their property. Utilizing both of these creates the best combination of liability protection and favorable estate planning.


In order to accomplish this, each property should be held in a single member LLC, with the living trust as the sole member of the LLC. In this setup, the trust is the owner of the company and holds all of the interests of the LLC.


In conclusion, utilizing both a trust and an LLC is one of the best ways to structure your assets when investing in real estate. Discuss with both your estate planning attorney and your tax professional to make sure it makes sense for you. You may also need to discuss with any lenders working with your properties to ensure all requirements are met. Once your LLC(s) is/are set up, let Nightfall Bookkeeping handle all of your ongoing bookkeeping tasks to make sure your business stays protected and is ready for tax season!

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