Protecting Your Assets
by Mike Butler
Protecting your assets should be a critical part of your investment program.
Years ago, we had several reasons not to worry too much about it. Here were some
of my excuses:
1.) The old “can’t get blood out of a turnip.” If you don’t have any assets,
there’s not much for them to get. When getting started, I usually didn’t have
much cash and not much equity. Not much there means not much for them to get. It
felt safe.
2.) Insurance was labeled as the first line of defense in the asset protection
arena. Buying good insurance and a lot of it was considered an acceptable way to
“buy” protection.
As a real estate investor, it’s easy to focus on the “deal” and the “numbers”
involving the performance of our properties. Capture another deal and you’ll
feel great and share the details over dinner and with your friendly competition.
Put a few of these in your pipeline and before you know it, you’re one of those
folks with something others might want to go after. Simply allowing yourself to
be known as a “landlord” or real estate investor implies you have a lot of
assets, deep pockets, and plenty of cash.
Before you know it, you might have become a bigger target than you could’ve ever
imagined, all from the result of your work, effort, and continued education and
knowledge. Protecting your assets becomes a number 2 quadrant activity of “not
urgent, but important.” We all just procrastinate. There’s not much excitement
in figuring out how to protect your self. It’s not as much fun as doing a deal,
cashing a big check, or collecting payments every month. It’s b-o-r-i-n-g and
usually involves having conversations with boring professionals who have their
meter running charging you to talk with them. Ouch! Developing an asset
protection plan is about as much fun as going to the doctor or dentist.
Let’s try it using the KISS method.
First of all, let’s try a simple comparison. Let’s use a good sharp fast sports
car. This sports car has the best and biggest 12 cylinder engine with the most
horsepower. It’s powerful. It can go from 0-60mph in 3 seconds. This sports car
has the best and smoothest transmission. It’s just a well-built and very fast
and sharp car. Sounds good so far, right? What if you put 4 different size tires
on this car because they’re cheaper or somebody told you to do it this way?
Wouldn’t this affect the performance? What if you failed to keep the proper air
pressure in all four of your different size tires? What if you never changed the
oil, air filter, anti-freeze? What if the car called for high octane fuel and
filled the tank with diesel fuel or kerosene because it’s cheaper?
I don’t know much about cars and really don’t plan on learning anytime soon;
however, I hope you can see how your high performance sports car could be turned
into junk in short order without proper preventative maintenance. The same
applies to protecting your assets. When gathering information to learn about
something, learn from somebody who has been there and done that. Would you want
to learn how to be a millionaire from a guy who speaks well and works at a temp
service making 20k annually? Would you go to a veterinarian for brain surgery
because they’re your buddy and will do it cheaper?
It urks me to see investors start off wrong with bad information from a trusted
friend who happens to be a professional. Be careful. Yes, I’m picking on
attorneys and CPA's because this happened to me too. These “friends” meant well
and really truly were trying to help; however, they were not experts in the real
estate investing arena. Protecting your assets involves several factors. Just
like the sports car, there are many parts to make this work properly. Proper
tires, fuel, driver and other parts all combined properly = good sports car.
There is no one button to push fixes everything. It just doesn’t happen so
easily.
For starters, many folks say “I don’t want to own anything. If I don’t anything,
I have no liability.” boloney! The only way to remove all personal liability on
your part is to get off the planet. You could own absolutely nothing and if
you’re driving your neighbor’s car to the grocery and run over the little old
lady pushing the buggy in the parking lot, guess who’ll get sued? The owner of
the car and the driver...you! So, bite your lip. You can never remove all
liability. This kind of exposure will be called the “back door.” When you get
sued from the “back door,” and they win, they get insurance money first. Then
they’ll get the things you own or have an interest in to satisfy a judgment.
It’s just plain ugly.
Protecting Your Assets Involves 3 Concerns
1.) Liability
2.) Tax Strategies
3.) Estate Planning
These three concerns each have unique and effective strategies for each benefit;
however, as shown in the drawing above, they overlap each other. They don’t
always compliment one another. This drives us absolutely bananas. When
discussing protecting your assets with your CPA, they will almost always defer
some questions to your attorney and vice versa. The point is, if you structure
everything for the simplest and best tax strategies, it’ll probably violate and
may not be the best for asset protection and/or estate planning. If you get a
super aggressive estate plan put together to make things easier for your heirs,
I’ll bet you’ve made things worse for your tax situation right now. (I did).
After a lot of research, expense, and growing pains here’s the simplest plan.
Take title to property using a land trust. A land trust simply hides the
beneficial interest from the public record. It does not exist for tax purposes.
It should not cost you a penny extra in closing costs.
Use “Single Member, Manager Managed LLC” (limited liability company) for
ownership of investment property. If set up properly, these entities do not
exist for tax purposes. They exist only for liability purposes. Treat them like
a business for liability concerns including a bank account for each LLC, but
everything gets combined and reported on your personal tax return as if they
didn’t exist.
As a rule of thumb, multi-member LLCs aren’t good. They cause you to file
another tax return. More tax returns equal more expenses for you. The same
benefit of the multi-member LLC can be achieved using a land trust with a 50%
beneficial interest for each single member LLC to replace a multi-member LLC
with two members. With a 3 member Multi-member LLC, simply have each beneficial
interest of 33%. The Single Member, Manager Managed LLC gives you the best of
both worlds. Used properly, it gives you the benefit of the old limited
partnerships without the added expense of another tax return.
In-House Property Management Company
Depending on the number of properties and your activity, you may consider a LLC
to be your own property management company. This entity can be used to wholesale
property and will be your “dealer” entity for tax purposes. Caution: The
management fee paid to your own management company will be earned income and not
passive. Earned income pays more income tax. This entity should not own assets.
It’s your out front entity with all the exposure, risks, and owns nothing.
Insurance
Have a policy for each property. The old-timer’s strategy of a good asset
protection plan is to simply have good insurance, and a bunch of it. Good
insurance might not be the best protection and is not the cure all today. Today,
insurance companies are bailing out and backing off all kinds of coverage.
They’re dumping mold and mildew, lead based paint, acts of terrorism, war, and
radon. Investors and homeowners are getting policies canceled because of certain
species of dogs, trampolines, and even macaroni and cheese in a pot on the back
porch. The list is getting longer and longer. Insurance is something you gotta
have, but you better not use. If you file a claim you’ll get on the nasty list
and your rates will go up if not canceled first. Save insurance for tragedies
such as major fires, tornadoes, hail damage. Do not use insurance for vandalism,
thefts, and bad cooking.
Deductible
Increase your deductible to $1,000 or $1500. If you file a claim, your rates
will go up or you’ll get cancelled. There is one type of insurance coverage that
does not gig you personally. Weather related tragedies such as hail, tornadoes,
hurricanes, etc. are labeled “catastrophic” by the insurance companies and are
not a reflection on your risk as an insured. If you go overboard on your
deductible to lower premiums, and raise your deductible to $5,000 or more,
you’ll miss the boat on hail damage and other catastrophic weather incidents.
Liability Coverage
Pay attention to your liability coverage. All the attorneys on TV are looking to
help somebody sue somebody. Good insurance with good liability coverage and an
umbrella policy as a back up plan are good front line defenses for you in the
liability department. As an investor, your liability coverage should be a
minimum of $1,000,000 or more.
Loss Of Rents
This highly promoted coverage is okay in the beginning with a just a few units.
It’s great if you have a multi-family building with 4 units or more in ONE
building. For example, a building with 18 units would be a good candidate for
Loss of Rents coverage. A fire or major casualty loss could cause the whole
building to be vacant overnight…. This coverage would be a great lifesaver here.
On single-family homes as rentals, you need to do the math. When you have 20
units or more, look at the added cost of the loss of rents coverage for each and
multiply it by the number of single-family homes. The benefit to the insured is
usually up to 6 months of rents paid. You’ll get to a point where the added cost
to your premium exceeds your 6-month rent benefit. When this happens or gets
close, whack it. I learned this from my insurance agent. Don’t confuse with
multi-family.
Umbrella Policy
Also called “excess liability” coverage. This can be an ugly monster if not
understood. Remember, insurance agents usually work on commissions. They want to
sell, sell, sell. Umbrella Policies got their name by the way the policy
operates. An umbrella policy does not cover everything and all of your loose
ends. It covers what is only under the unbrella. If you have a policy with
insurance company A, and you have an umbrella policy with Company B, odds are
your umbrella won’t cover or stand behind company A’s coverage, especially if
you fail to tell them about the Company A policy.
Agent / Company
Having one competent agent for your insurance concerns can be a huge benefit for
you. Sure, they can go belly up, lose your business, and you can switch
companies; but you’re less likely to hiccup, hit a pothole, or forget something
like those umbrellas. It will eliminate the need for two or more umbrella
policies and the added stress of making sure all of your properties and
activities are included under the two or more umbrellas.
Imagine for a moment you have two or more insurance agents and companies.
Insurance Agent A, B, and C. Each agent has policies covering some of your
properties. Each has an umbrella for their policies. You are an aggressive real
estate investor and you buy and hold with tenants, and buy and sell some to feed
the machine. What a mess! Odds are you will get gigged on extra premiums and you
must always remind your agent A, B, C to add / delete properties on regular
insurance and each umbrella. Now, suppose you have one agent with Company A.
Easier for me, easier for them. You can structure your umbrella to cover all
policies with Agent A. No need to worry here. If you choose not to use an
umbrella policy, you better load up real good on the front policy. I suggest
again, a minimum of $ 1,000,000.
Separate Policies
You can argue this one all day long. It’s absolutely easier, safer, and more
efficient to have a separate policy on each property. Do not get a commercial
policy adding more units, buildings, and etc. all on one policy. This makes it
easier for the agent and horrible for you. It actually reduces your coverage!
Benefits
•Each property stands on its own policy and it’s own deductible.
•Each property with its own policy covers you better.
•Provides you with greater privacy protection. Lenders receive only proof of
insurance for the one property listed. If you have a hard money lender or a
seller financed property requiring proof of paid insurance, they receive only
the policy for the property. If you use the agent friendly commercial policy,
they will receive a list of everything you own.
•Allows you better control, especially on jumped loans. (subject to)
•Lawsuit Time: not if it happens, but when. When it does happen, one of the
first things the attorney asks for and will receive without your consent is a
copy of the insurance policy. Once again, the dirtbag attorney may receive a
list of all your properties.
•Houses and garages may be listed as individual buildings. It can be cumbersome
keeping track of building 36 and 37 in relation to addresses, especially if you
sold some of them.
•Better Coverage: with each property having its own policy, each has a
deductible and a liability limit. The liability limit usually has 2 numbers. The
first is the limit of each occurrence. The second is the total aggregate for the
policy. In simple terms, if you get sued they may pay up to the first limit for
each occurrence. If it happens again during the same year, they may pay again
providing it does not exceed the second number. With the commercial policy
listing all of your properties, you still have a first number and a second
number, all on one policy. So if you get sued, they may pay up to the first
number for the first occurrence. If it happens again during the same year, it
could totally wipe out your liability coverage on all of your other properties.
•Payment of Premiums: with individual policies, premiums are usually paid a year
in advance. You’ll have staggered premiums due throughout the year for better
budgeting. A commercial policy zaps you one time annually and properties added
and deleted throughout the year have pro-rated premiums based on your effective
date. It’s a mess if you’re busy.
Jumped Loans – (Subject To)
Investors have been told “add your name to the existing homeowner’s policy.”
Dangerous! We’re real estate investors, not homeowners! Remember, agents make
their money by selling, and earning commissions. How many homeowners’ policies
have liability coverage of $1,000,000? The policies I’ve seen have jewelry,
boats, minimum liability coverage, and all kinds of garbage you don’t need.
plus, it usually costs more.
If you’ve jumped or bought subject to on a property with a delinquent loan, odds
are they’re in a “forced insurance” plan at the direction of the lender. Super
expensive, their forced insurance is usually 3 times the cost of good insurance
with absolutely no liability coverage. None. Why in the world would you want to
continue this policy and add your name as additional insured? Crazy and
Dangerous!
Again, use your agent and get your own individual policy for the property adding
the seller(s) names to your policy as “additional insured” to satisfy the
lender. Don’t try to argue and say something like, they have good insurance and
it’s being paid from escrowed funds. As investors, we’re tightwads, but the
purpose of insurance is for tragedies. So what, the worst-case scenario is you
may pay for two policies the first year you bought the property. After you get
everything squared away with the lender and correspondence coming to you about
the loan, if insurance is paid from escrowed funds, cancel the existing policy
purchased from the sellers and replace with your policy. They’ll do it most of
the time as long as the borrower(s) name(s) are on the insurance policy.
This simplified version of protecting your assets should not cause more expense
from additional tax returns. Protecting your assets doesn’t address any issues
regarding estate planning; but, make yourself aware of how each of the 3
concerns overlap and violate each other if each is done properly. So there is no
one simple plan to fix everything. Just like the fine tuned sports car,
protecting your assets involves several pieces and parts all working together
properly.
Bio:
Mike is a focused, aggressive real estate investor, who takes pride in avoiding
banks to buy investment property.
Mike realized early on he MUST have a strong foundation to grow quickly and
safely. Mike has reviewed many property management software programs only to
discover they fell short of what he needed. Mike has spent thousands of hours
tweaking and researching Quicken and QuickBooks Pro. His method is getting the
results that he needs.
In May 2002, Mike was invited to be a featured speaker at a regional conference
of CPAs and the rest is history. His simple laid-back street level teaching
style is easy to understand and benefits all levels of investors, from the
beginner to seasoned veteran.
Successful investing utilizing tenant tracking and effective property management
and bookkeeping techniques enabled Mike to retire in March 2000 after 13 years
as a Louisville Police Detective.
He was featured in Money magazine, June 2001, in the article “Can Real Estate
Make You Rich?”. Mike Butler is a Kentucky licensed real estate broker, a
realtor, member of KREE, and a charter member of NARPM.