Asset Protection vs. Asset Distribution

It all sounded easy when you started buying rental properties. Just buy enough to make a bit each month and eventually you can retire with great supplemental income. Perhaps a death in the family provided your first rental property or perhaps you decided to convert your principal residence to a rental.

Wealth Building

Over time, you pull equity from one rental to buy the next. The years go by and before you know it, by golly, you have quite a few. Or perhaps your wealth building plan is to buy vacant land, build and resell. Because you never know where life will take you, you’ve heard that your assets should always be put in a trust. That way, there’s no probate if anything happens. You’ve heard the trust also protects you if a tenant or worker is hurt on your property. To which I say, not so fast!

What is a Trust?

A trust is a device used to distribute your assets (stuff you own) upon your death. In most states, it typically does not provide protection if anyone is hurt on your property. Even if you have insurance on the property, it could be possible for an injured party to go after all your other assets as well. For this reason, most real estate attorneys and CPAs will recommend an LLC (Limited Liability Company) or corporate entity be created to shield your liability. This is called asset protection. Not as simple as it all sounded at first, right?

Taking a Loan

Here’s another twist. Taking a loan on a property? Most lenders don’t loan to your LLC or asset protection vehicle so it’s good to ask your lender prior to transferring property to such an entity. A trust is generally ok. Further, I’ve been advised not to put my principal residence in an LLC. It makes perfect sense. When I sell, I am entitled to the capital gains exemption extended through IRS Section 121 ($250k for single/$250k tax free for couples). I am not an LLC and LLCs don’t qualify. Speaking of the 121 exemption, what if you lose a spouse? This continues the spouses’ entitlement for three years so (for a few reasons) the time to sell might be during that period.

While this is really not my wheelhouse, these are important concepts to consider as you go along life’s real estate journey. Be sure to ask and act accordingly, and by all means, buy that rental property while you enjoy the income and all the other tax benefits as well.