As a real estate investor, you've undoubtedly heard that the LLC (Limited Liability Company) is a powerful asset protection vehicle. Savvy investors create LLCs for their properties to shield their personal assets from any liability with the investment property.
With any property, there are inherent liabilities — from a broken balcony railing to old electrical wiring or mold. And with an LLC, your personal assets aren't vulnerable should you be sued by a tenant or property guest.
Forming an LLC is a relatively quick and painless process. And while it may straightforward, there are some common mistakes that investors make that can impact the benefits of the LLC:
1. Failing to create a separate LLC for each property: If you own multiple investment properties, you should set up a distinct LLC for each property. This practice will give you the greatest amount of liability protection for each investment. If Property A is sued, only those assets belonging to LLC A are affected. Your own personal assets are shielded, as well as the assets from Property B (LLC B), Property C (LLC C), etc.
2. Failing to transfer the property deed to the LLC: Once you have established an LLC, you need to sign a deed transferring the property to the LLC, and then record the deed in the county where the property is located. This may sound like an obvious step, but do not overlook it. If you never actually deed the property to the LLC, you (the individual) are still considered the owner and will be the defendant in any lawsuit. Of course, if the LLC purchases the property, you do not need to worry about transferring the property deed.
3. Hiring an expensive lawyer to form the LLC: You don't actually need to hire a lawyer to form an LLC. If you've got a straightforward investment situation, you can use a legal document filing service to represent yourself to create an LLC. In the eyes of the law and IRS, your LLC will be just as valid than if a high-priced attorney sent in the documents for you.
4. Failing to keep the LLC in compliance: If a plaintiff shows that you have not maintained your LLC to the letter of the law, he or she can seek recovery against your personal assets. In short, the LLC's shield that protects your personal assets is pierced. So, how do you make sure your LLC stays compliant? Keep your personal funds separate from those of the LLC (no commingling: this means keeping a separate bank account and credit card). Remember to send in your Annual Statement/Annual Report (if required by your state). And obviously, do not engage in any form of fraud.
5. Not insuring the property under the LLC: You should purchase a comprehensive landlord's property insurance policy (or as applicable) to protect your property from damage and liability. And make sure you have written proof showing that the LLC is a name insured (otherwise, your insurance company may deny coverage when it comes time to make a claim…). And if you have multiple properties/LLCs, each LLC should be separately insured.
By avoiding these five common missteps, you can better protect your assets, minimize your liability, and enjoy a successful investment for years to come.