Creating a separate legal entity for buying a second home is a smart way for ordinary households to protect themselves.
By Bruce Ailion, Licensed Attorney and Broker Affiliate with Re/Max Town and Country, Woodstock, GA
If you're working with a couple interested in buying a second home as an investment property, you might suggest they talk to a lawyer about setting up a limited liability corporation or other legal entity before they buy. That way, if they're sued by someone who was on the property after they bought it, they can limit their damages and protect their personal assets against losses.
Suppose a contractor they hire makes negligent repairs to a deck and it collapses while tenants and guests are having a barbecue. The judgment in a case like this could easily exceed the equity the owners have in the property and even the coverage limits on their insurance policy.
Or perhaps they rent the property to a person who own's a dog not covered in a typical landlord policy and the dog bites someone on the property. State Farm, for example, won't cover bites by rottweilers, chows and about a dozen other breeds. The company paid $121 million in dog bite claims in 2016 at an average of $33,000 a claim. A claim of that amount might exceed the equity the homeowners have in their property. That could make their personal assets vulnerable to the judgment.
Or let's say the carbon monoxide detector is faulty and the property has a 20-year old furnace that develops cracks, releasing gas indoors. Tragically, a family of four staying in the property is killed. The owners could face four wrongful death actions caused by negligence.
Gravity of Risk
These are rare occurrences, to be sure, but they point to the gravity of risks that investment property owners can face. In fact, the scenarios illustrate one of the main differences between real estate and other types of investments like stocks or bonds; real estate can carry risks that exceed the investment of the asset.
Of course, an owner's first layer of protection is insurance, but owner's might fail to recognize that their losses can exceed coverage limits. Or there may be expectations or carve-outs in the coverage that exclude or limit the losses, such as State Farm's exclusions for certain dog breeds. These gaps in coverage might expose the owner to unlimited liability. In today's litigious world, $100,000, $300,000, or even $500,000 liability coverage may be inadequate. Also, owners converting their home to an investment property might not think to take out landlord or vacant property coverage.
To get the right amount of protection, buyers should strongly consider a personal liability umbrella policy with $1 million to $2 million in coverage. But they should also consider forming and running a corporation or LLC. The type of entity they can form varies and is governed by state law, but nearly all states allow incorporated entities like limited liability corporations, partnerships, C corporations, and subchapter S corporations.
Deciding which type of entity to set up and how to structure it should be done with advice of counsel. The process may not be expensive. Depending on the area and particularities of the household, the legal work can be done for a few hundred dollars. There are also do-it-yourself forms online, but self-help isn't recommended; these entities, whether for your own investments or your clients', have to be set up correctly to get the maximum protection.
Investing in real estate can be a smart decision. The right property can outperform other investment vehicles. But because real estate investments come with potential pitfalls, it makes sense to have sufficient insurance and for investors to consider setting up an LLC or other type of entity to separate their liability from their personal assets.
For all your real estate needs:
Rogers Healy and Associates
K&C Real Estate Group
Author:Keith Tobas Phone: 917-912-5738 Dated: April 24th 2018 Views: 356 About Keith: Dallas Luxury Homes with Keith Tobas;
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Ashton is a born and bred Texan and TCU graduate with a real passion for helping people achieve their goals. Real estate became the perfect career to combine this passion with her strengths in research, marketing, communication and construction. Ashton’s specializations are in residential buyer and seller representation and residential investment properties, but she has experience in new construction, leasing and property management and farm and ranch properties. While she calls Fort Worth home, Ashton has worked is areas stretching across the Metroplex from Weatherford to Dallas. As they say, have license, will travel. Ashton is also an Accredited Luxury Home Specialist and Certified Negotiations Expert and holds her Graduate Realtor Institute certification through the Texas Association of Realtors. Outside of her career, Ashton enjoys being active and outdoors, volunteering with various organizations including DFW Labrador Retriever Rescue and Susan G Komen, and traveling whenever she can.