#rentalproperty

If you are in the minority of Americans who are contemplating purchasing another home as a rental property or already own a rental property, you are probably doing fairly well in life to be in that position. Without running the numbers on your financial situation, the main question that we hope that you have the answer to is, “What happens to me financially if someone sues me?”. If your answer is anything other than “My household and personal assets are protected and I will be fine”, you hold your financial plan under the microscope and find out where the gaps in your financial plan are. Asset protection strategies like purchasing an umbrella insurance policy or putting your current or future rental property(ies) in an Limited Liability Company (LLC) can help fill in those holes in your financial plan. I’m sure that you worked hard to be in the position financially you are in today and would hate to see your success derailed by a car accident that was your fault or a tenant slipped and fell in your rental home and sued for damages. Let’s walk through a summary of how an umbrella policy and an LLC are used and how they can benefit you.

Umbrella Insurance

An umbrella policy is a type of insurance that is sold in increments of $1 million of coverage and is relatively inexpensive at around $20-40 per month per $1 million of coverage. If we take the example of a car accident that was your fault, the person you hit may not have good health insurance and may require substantial medical bills. If your auto insurance coverage is only good for $500,000, you are personally on the hook for the remainder. Think of auto insurance as a bucket, the money needed to pay the injured person’s medical bills as water, and umbrella insurance as an upside-down umbrella underneath the bucket. Assume that the total cost to make the injured party whole is $750,000. Let’s assume that your auto insurance coverage is only good for $500,000 and in one scenario you have a $1 million umbrella insurance policy and in the other scenario, you do not have umbrella insurance. The diagram below illustrates what happens to you in each case.

I assume that if this was you, you would rather be the person on the left who is dry, thanks to the umbrella policy stepping in and paying the additional $250,000 than having to come out of pocket personally for the $250,000. The person on the right may not have $250,000 in cash to be able to account for this cost and may have to sell stocks in investment accounts, take out a personal loan, or sell a rental property to cover the cost and could end up owing more than $250,000 in the long run due to taxes or loan repayments. This can be costly to your long-term financial goals and could have been resolved with a relatively inexpensive insurance policy.

Limited Liability Company (LLC)

A Limited Liability Company (LLC) is an entity that you can establish to allow you to have your rental property(ies) transferred to the LLC to separate your personal property from your rental property(ies). Assume that you have a tenant who slips and falls down your staircase because you didn’t repair the railing after an inspection. The tenant can then sue you for negligence. If that tenant decides to sue you and you have an LLC set up, the tenant is only suing the LLC and cannot go after your personal property. If you do not have an LLC set up, the tenant can also go after your personal property.

Another nice thing about umbrella insurance is that it can also be used to help cover legal damages incurred from a lawsuit at a rental property up to the coverage limits of the umbrella policy. Unlike umbrella insurance, setting up an LLC or multiple LLCs can be expensive to establish and administer. In California, there is an annual $800 fee that must be paid each year until you cancel your LLC. We also recommend that you go to a reputable attorney to establish the LLC and attorney fees can range from a few hundred dollars to a few thousand dollars. Properties owned outside your state of domicile might also require a separate LLC for each state you own real estate in.

Summary

The exact amount of umbrella coverage and whether or not an LLC is appropriate in your situation depends on your unique financial situation and if you are unsure of how to implement these asset protection strategies, our team of CFP® professionals at BFSG can diagnose your financial plan to help determine what asset protection strategies are appropriate for you. Please feel free to reach out to us at financialplanning@bfsg.com or give us a call at 714-282-1566.

Sources:

1. https://www.bankrate.com/insurance/homeowners-insurance/home-ownership-statistics/#stats
2. https://www.ace.aaa.com/insurance/personal-umbrella-insurance.html
3. https://www.investopedia.com/articles/investing/121015/real-estate-trust-or-llc-helping-landlords-choose.asp

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

By one estimate, U.S. landlords were owed about $57 billion in unpaid back rent at the beginning of 2021. The average household that fell behind owed about four months of rent, or $5,600. Altogether, more than 10 million U.S. families were facing the possibility of eviction.¹

Many landlords, including those who depend on rent payments for retirement income, have experienced financial difficulties in lockstep with their heavily impacted tenants. Although multi-family apartment complexes are often owned by large corporations, about 90% of single-family rentals are owned by small investors who are facing the risk of mortgage default, bankruptcy, or forced property sales.²

Fortunately, the March 2021 federal stimulus bill added almost $22 billion in housing assistance to the $25 billion previously allocated by Congress.³ In many cases, payments are being sent directly to landlords through new or existing local programs on behalf of renters who meet certain eligibility requirements.

Program parameters

Under the Emergency Rental Assistance Program (ERAP), the U.S. Treasury has distributed grants to states, cities, and counties with populations greater than 200,000 to be used for back-due rent and utility bills accrued after March 13, 2020. Eligibility is limited to households that earn less than 80% of the area’s median income, as defined by the Department of Housing and Urban Development.

Applicants must document their incomes, prove they qualified for unemployment benefits or suffered financial hardship due to COVID-19 that impacted their ability to pay rent, and submit unpaid bills or notices that demonstrate they are at risk of becoming homeless.

What can landlords do?

Tenants and landlords generally apply for the funds together, but the application process and guidelines differ from program to program. In some states, landlords may be asked to forgive a percentage of the rental arrears in exchange for larger rent payments.

If you are a landlord, you might reach out to tenants who are behind on rent and encourage them to explore any potential opportunities for financial assistance. Check the websites of your state and local housing agencies to find the status and requirements of various housing programs and how to apply. Of course, many higher-earning households won’t be eligible for help, and in areas with lots of lower-income renters, local programs could run dry quickly.

Evicting tenants can be a painful and expensive process. If you have tenants who fell behind but are trying to catch up, it may be advantageous to work out a payment program instead to help keep them in place.

Sources:

1. Moody’s Analytics, 2021
2. RealtyTrac, 2021
3. The Wall Street Journal, March 11, 2021

Prepared by Broadridge Advisor Solutions. Copyright 2021.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

One of the most common questions people ask is why they need (or what is the best) to use an LLC or umbrella coverage if they own rentals. If you are sued, you will want to have some form of protection to make sure your other assets like your primary residence and retirement accounts are safe. This is an important part of planning when you have rental property but unfortunately is often overlooked. Let’s review using an LLC or umbrella policy and discuss the merits of both.

Basics of Umbrella Policy

As the name implies umbrella insurance is a sort of catch-all that provides additional protection for the “What If’s” that works to protect you when you reach the limits of other insurance policies like homeowners or auto. Imagine you are sued for $1 million for a car accident you caused, and your auto insurance coverage only goes up to $500,000. If you are found at fault you would be on the hook for $500,000 without umbrella coverage but if you have umbrella coverage it would cover the remaining amount up to policy limits. Take a look at the example below:

The great thing is that with an umbrella policy you are protected whether something happens to you personally (i.e. auto accident) as well if something happens at your rental properties. Umbrella insurance provides great benefits for a relatively low cost. The downside is that if the claim exceeds your umbrella policy you are on the hook for the excess amount.

Basics of an LLC

A Limited Liability Company (LLC) is designed to provide asset protection by separating your personal property from your rentals. By establishing an LLC, if you get sued, they are suing the LLC and thus you are protecting your personal assets from the lawsuit and only the assets in the LLC are at risk.

If you have multiple properties it becomes expensive and difficult to qualify for the proper insurance amount. If there are multiple properties it is common to establish an LLC for each property for further protection. If you have a property in multiple states, you will need to establish an LLC in each state you have a rental. The disadvantage to LLCs is that the paperwork can be a pain and they can be expensive. For example, in California, it costs $800 a year for each LLC you have. This can be very expensive if you have multiple rental properties. Another drawback is getting a mortgage for a property in an LLC is more difficult and typically has higher interest rates.

What is best for me?

It will depend on your rental property strategy, your cash-flow, the risks you are willing to take, and your situation. Neither strategy is full proof, and both have important strengths and weaknesses.  Please understand your state rules also impact which strategy is best for you. Please contact us or your attorney to discuss your situation in greater detail.