You can take matters into your own hands by forming a company–the LLC–to own the rental property.
If the tenant is going to sue for an injury related to the rental property, he/she must sue the owner. If the owner is an LLC that you control then it acts as a shield protecting your assets from the lawsuit. Yes, the assets of the LLC are exposed but the LLC should only have minimal assets in the form of one bank account for paying the bills related to the expenses of the rental property. The equity of the property is also exposed as it is an asset of the LLC; however, all your other assets are now protected from the claim of the tenant (there’s actually a “dirty little secret” about LLCs that require the use of the NAPT but more on that later under the heading LLC Dirty Little Secret #1, below).
There are two types of LLCs: (1) traditional LLCs and (2) Series LLCs.
Every state has the traditional LLC and each of those states’s LLC statutes provide excellent Inside Liability protection from tenants. However, a select few states provide both Inside Liability protection as well as some Outside Liability protection. Now, to be clear, only when the LLC is combined with the NAPT can you achieve a high level of Outside Liability protection. Yet, the LLC’s Outside Liability protection qualities (when formed in the proper state) are a vast improvement when compared with just owning the property in your name.
The Outside Liability protection we’re referring to is called the “Charging Order.” Let’s say you get sued–not from a tenant (the Inside Liability) but from a vendor on a breach of contract. Let’s also assume you lose the lawsuit. When the vendor (now called the judgment creditor) comes after your assets to collect the judgment, it will not have direct access to the rental property if the rental is owned by a LLC formed in a state where the Charging Order is the sole remedy for an Oustide Liability creditor.
The Charging Order only gives the creditor a lien on the distributions that the LLC makes to the owner (you). So if the LLC doesn’t make any distributions, the creditor gets nothing. Now the creditor must wait…and wait…and wait. This could go on for years. Meanwhile, the LLC continues to manage and grow its assets (but See LLC Dirty Little Secret #2, below). The downside is that you cannot use the LLC assets for your personal benefit. The assets are safe but trapped. Because the creditor wants paid and because you want to use your LLC assets for your personal life and you don’t want to live your life with a judgment against you, normally you and the creditor will settle. How is this protecting you? Keep in mind that we said the LLC (if formed in the right state) provides some Outside Liability protection. It’s not even close to perfect, but it’s better than nothing. Because if you didn’t have the LLC, the creditor would have had free and direct access to the equity in the rental. With the LLC you not only have excellent Inside Liability protection from a tenant suing, you also have some Outside Liability protection.
Two states where the Charging Order is the sole remedy: Wyoming and Nevada. Wyoming invented the LLC in 1977 and it continues to have excellent Outside Liability protection when compared to other states. Nevada also provides what we consider to be the same protection level as Wyoming. While other states provide some Outside Liability protection like Wyoming and Nevada, we form LLCs in these two states because it covers all our client’s needs. Wyoming is cheaper when it comes to filing fees so this is the state we use when our clients do not reside in Nevada. As many of our clients do reside in Nevada or they have business in Nevada, Nevada LLCs fulfill our client’s requirements in these cases.
Series LLCs present a solution that arises with traditional LLCs that own multiple rental properties. If you have a traditional LLC owning one rental property and it owns a bank account to pay expenses, the loss from a tenant suing the LLC is limited to its bank account and the equity contained in that one rental property.
If you have two rental properties in the same LLC, the potential loss from a tenant suing increases to an amount equal the bank account plus the equity from both properties. If there are three properties then the potential loss increases once again to the LLC’s bank account and the equity from all three properties–and so on.
The normal strategy has been to create another LLC to hold the second property such that if there is a tenant injured on the first property that liability doesn’t bleed into the second property. If there are three properties, then three LLCs would have to be formed to limit the exposure. Each LLC has annual fees, annual accounting, annual taxes and annual minutes that should be kept. Plus, in order to respect the company formalities, each LLC should have its own bank account. These administrative burdens and fees can really add up and, in the end, we’ve seen folks simply give up on the protection and revert back to their simpler–albeit naked–life.
The Series LLC solves this problem. Now one LLC can be formed–called the master–and under it separate compartments or series can be formed. Each compartment is treated as its own LLC. Each rental property is owned by separate series. Let’s say that you have two rental properties. You can form a Series LLC with three series. Series 1 owns rental 1, Series 2 owns rental 2 and Series 3 owns the bank account. An management agreement exists between Series 1 and Series 3 and between Series 2 and Series 3 for Series 3 to handle all the rents and expenses of the other series. If there is a tenant injured on rental 1, the tenant can only sue Series 1 whereas Series 2 and Series 3 are protect (but don’t forget LLC Dirty Little Secret #1, discussed below).
Because the tax treatment of each series is identical, the series are collapsed into one tax return. While there still should be separate books for each series, usually done as classes in Quickbooks, there is only one annual Secretary of State filing fee and that can add up to series savings over time. We recommend a Series LLC if you have two or more Nevada rentals. Because the Series LLC is unique to only a few (last we check 3) states, we recommend you use the traditional LLC to hold property located in other states.
Single-Owner Nevada or Wyoming LLC Price is for one owner or husband/wife
$1,175Per LLCYou won’t find a cheaper price from an attorney of our caliber. Includes operating agreement, EIN and counseling with the attorney. Two or more owners add $500 for the extra counseling, design and Buy/Sell Agreement. Fees include the legal fee, the resident agent fee for the first year and all Secretary of State (“SOS”) fees for the first year. While the SOS fees in Wyoming are lower, the resident agent fee is slightly higher. Annual fees: Nevada $475; Wyoming $300.
Nevada Series LLC (Wyoming does not have a Series LLC) Includes the Master and One Series
$1,725Per LLCAdditional series are $250 each. Includes operating agreement for master and one series, EIN and counseling with the attorney. No additional fee for multiple owners. Fees include the legal fee, the resident agent fee for the first year and all Secretary of State fees for the first year. Annual fee: $475. There is only one fee for the entire Series LLC–not for each series inside the company–thus creating one of the primary advantages over traditional LLCs.
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We’re hiding the secrets at the bottom of the page to poke fun at the attorneys and online LLC “do-it-yourself” companies that fail to tell you the full truth about LLCs.
LLC Dirty Little Secret #1
You’ll Still Get Personally Sued (as the Manager of the LLC)
Yes, the Inside Liability protection is quite strong when the rental property is owned by the LLC. Yes, if the tenant is going to sue for an injury related to the rental property, he/she must sue the owner which is the LLC (if an LLC is utilized to own the rental property) BUT…
The LLC Dirty Little Secret #1 is that the tenant can (and will) sue the manager(s) of the LLC.
The manager of the LLC is like the president of a corporation. The manager, among other duties, (1) controls all the assets in the LLC, (2) determines when to make distributions to the owner and (3) is the signer on the LLC bank account. If you want to control the LLC then you will be the manager. If you are the manager, then you probably will get sued in your capacity as manager (not owner) of the LLC. Remember, the owners are limited in the amount they are liable for any claims against the LLC equal to an amount that the owner invested in the LLC. Hence, the owner can lose the equity in the rental property he/she put into the LLC and any assets in the LLC that the owner had a right to receive in distributions. That LLC shield for the owners is very strong and it’s hard for the tenant to penetrate it. However, when you are personally sued for the LLCs problems you are getting sued because you are the manager.
So the Inside Liability of the LLC has now flipped to an Outside Liability for you. That is why you must use the Nevada Asset Protection Trust (“NAPT”) to protect all your other personal assets from any Outside Liabilities. Read about how the the NAPT protects you from Outside Liabilities here.
Now, for those that do admit the manager does have this problem they suggest a solution that is wholly unsatisfactory in having another LLC formed to be the manager. So now more fees for the attorney or online company making this recommendation. More annual fees for you. More books for you to keep. More headache. More unnecessary complexity. It’s only adding more expense but not more protection. Here’s why. If LLC(1) is sued and the manager is sued but the manager is another LLC–LLC(2) then the manager of LLC(2) is going to get sued. If the manager of LLC(2) is you, then they “gotcha.” Some unethical “advisors” may suggest yet another LLC–LLC(3) to serve as the manager of LLC(2), and on and on.
You will want to control the LLC, so be the manager. We just want you to be aware that at some point you will need to add the NAPT to your plan to properly protect you from all Outside Liabilities–including the one created as a result of the LLC. Remember, the LLC is not creating more liability for you. It’s actually reducing it significantly by isolating almost all the Inside Liability to the LLC itself. Just be aware that you, as the manager, may have some exposure that will be isolated with the NAPT.
LLC Dirty Little Secret #2
Creditors Can Bypass the Charging Order with a Fraudulent Transfer Claim
Yes, the Charging Order, if it’s formed in a state like Wyoming or Nevada, will provide some Outside Liability Protection BUT…
The LLC Dirty Little Secret #2 is that even in states where the Charging Order is the sole remedy for a judgment creditor, it takes at least 4 years for the assets you transfer to the LLC to be safe from an Outside Liability attack against you.
Every state has a fraudulent transfer law which a creditor can use to reverse the transfers you make to any person or any entity such as a LLC. See our brief discussion of fraudulent transfer laws here. So if you lose a lawsuit and the judgment creditor (the plaintiff who won the lawsuit) comes after your assets, he/she can get to the assets of your LLC if you transferred those assets to the LLC within the last four years. This 4-year window is the seasoning time period required to protect assets. And it’s at least four years. The creditor also has 1-year from the date they discover you made a transfer to the LLC. So, if the judgment creditor didn’t discover you made the transfer until four years after you made the transfer, he/she will get until year 5 to reverse the transfers you made to your LLC.
Some states the seasoning window is at least 6-7 years. So, for Outside Liability protection, we strongly recommend the use of the NAPT in combination with the LLC to reduce the season window to a maximum time period of 2 years. If not, you can be left with the judgment creditor sucking the assets out of the LLC and you’re left with nothing but a shell for a LLC.