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.