SMART REAL ESTATE INVESTING PROCEDURE
Protecting Your Personal & Investment Assets
When investing in real estate, as with any business venture, it is important to plan so that you can limit your exposure to liabilities that could result in the loss of your own personal assets and/or your investment properties.
When planning for protection, there are two directions from which potential liability and risk can come.
From the "front end" (from operating the business or the property) and from the "back end" (from your own potential judgment creditors).
In devising any investing and asset protection plan, the potential risks from both the front end (from the business or operation of the property) and from the back end (from potential personal judgment creditors) should be carefully evaluated and considered.
Defining "Front End" Risk:
Whenever you do "business" with the outside world, whether it is operating a retail business, a service business or even renting out residential or commercial real estate, there is always some risk that a lawsuit may arise from that business activity. In the real estate realm, that lawsuit might occur because someone is injured on the property, because of a toxic mold issue, or perhaps because of a contract dispute or for many other potential causes. Whatever the reason for the lawsuit, if you have not properly shielded yourself, your own personal assets may be put at risk of loss to a legal judgment. If this occurs and you are not protected, your own home, cars, bank accounts and other valuable assets that you have worked so hard to accumulate could be lost.
Defining "Back End" Risk:
When referring to "back end" risk, we are talking about the risk that someday you might be sued personally. Such a lawsuit could occur because of a car accident where another party is injured or killed,
because of an inability to pay your own personal debts because you're having a financial crisis, or for many other conceivable causes. Regardless of the reason for the lawsuit, if the claimant is successful in obtaining a legal judgment against you, your personal assets may become fair game for the judgment creditor to seize and to sell to satisfy their money judgment against you.
PROTECTING YOURSELF FROM FRONT END AND BACK END RISK WHEN INVESTING IN REAL ESTATE:
One rule that you should learn and live by is that you should never operate a business as a Sole Proprietorship or Partnership. A summary of the reasons that you should abide by this rule is as follows:
• Your personal assets are completely at risk for all business debts and liabilities
• There are no hoops for creditors to jump through to get to your personal assets
• Partners are liable for the acts and liabilities of other Partners
Remember, owning and renting out even residential real estate is "doing business" and it exposes you to some degree of risk.
The best way to limit your Front End risk is by putting the real estate property into a Corporation or Limited Liability Company (LLC).
CORPORATIONS VS. LLCs
Either a properly formed and operated Corporation or LLC will provide a shield of protection between the business front and yourself personally. However, there are a few distinctions between the two types
of entities that should be considered. Ultimately, the LLC provides better protection, especially from the "back end" risks.
Corporations are required by law to do some specific "corporatey" things. For example, even in Nevada, Corporations are required to:
• Hold organizational meetings and keep minutes of those meetings (even for a 1 person corporation)
• Adopt Bylaws and follow them
• Appoint officers and directors (in Nevada 1 person can hold all of the offices)
• Issue stock certificates
• Hold annual meetings and keep minutes of the meetings
One other downside to a corporation is that fact that if someone got a judgment against one of the corporation's shareholders/owners, that stock ownership is considered a personal asset and is "attachable" or "executable" by a the judgment creditor.
Thus, the judgment creditor could take control of your interest in the corporation and sell of the assets to satisfy their judgment against you personally.
• Nevada LLCs are not required to hold organizational or annual meetings/No Minutes or resolutions required
• Not required to appoint officers or directors
• Operating Agreement or Bylaws are not required (although an Operating Agreement is advisable in every case)
• Ownership Certificates are not required
• Maximum Flexibility of internal governance without "Statutory" imposition (you decide how you want to govern your own LLC instead of the state imposing a laundry list of internal company governance requirements)
• Offers some "Back End" Protection that a corporation does not
Unlike corporations, membership interests (i.e., ownership interests) in an LLC are not directly "attachable" or "executable" by Judgment Creditors (remember, Stock in a Corporation is attachable by Judgment Creditors).
The only remedy for a Nevada LLC member's personal judgment creditors is to obtain a "Charging Order" to "charge" (much like a "lien") the member's right to receive a distribution of profits or monies from the LLC when a distribution to the member is made.
However, the charging order does not give the judgment creditor the ability to force a distribution of money from the LLC, it does not give the judgment creditor the ability to control or vote your interest in the LLC, and it does not give the judgment creditor the ability to force a sale of company assets or a dissolution of the LLC so that they get paid.
The judgment creditor just has to sit and wait and hope that there is a distribution to the member someday and that they get paid. Of course, if someone has a charging order against your membership interest in the LLC, you just don't distribute any money from the LLC to yourself until the
coast is clear.
There just happens to be a big disincentive for the judgment creditor to want to go to court to get a charging order against the person's membership interest in the LLC. The disincentive is that the IRS takes the position that if someone has a "charging order" against an LLC member's interest in the LLC, the person with the charging order will be taxed as if he/she actually received the distribution of money, whether or not the person actually receives it.
So, in sum, the person with the charging order runs the risk of paying taxes on money they will likely never receive. So, if they're not asleep at the wheel, judgment creditors will not seek a charging order in the first place. If they do get the charging order, when the person gets their first tax bill for profits that they never received, they are likely to run back to
court and try to cancel the charging order.
This is quite effective "back end" protection of your LLC interest (which is really protecting your real estate that is held by the LLC). Additional planning can be done to protect your other personal assets through use of a Nevada Onshore Trust.
For more information on the Nevada Onshore Trust, see www.RDJohnsonLaw.com
By: ROBERT D. JOHNSON, ESQ.
R.D. JOHNSON & ASSOCIATES, LLC
2575 So. Cimarron Rd., Suite 202
Las Vegas, Nevada 89117
The information contained in this document is not intended as legal advice. You should consult an attorney for individual advice regarding your own specific situation. Unauthorized duplication, distribution or publication of this copyrighted material is prohibited. Used with permission.