How to Protect Your Assets While Investing in Real Estate Rental Properties
Protecting your real estate investing business is absolutely vital to securing the future of the business. If you wait until you are being sued to worry about asset protection, you are already too late.
On today’s show, I am talking with a lawyer, Andrew Magwood, from Magwood Law Firm.
He is going to talk to us about protecting our properties and making sure we have a lasting legacy we can pass down to our children and grandchildren.
We are going to talk about how to set your business up right, from the beginning. Andrew is who I work with, and he helps me protect my business.
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When should an investor talk to a lawyer?
Before you put ink on paper for any deal, you should have an attorney you have retained who is in your corner.
Too often, someone will come to Andrew who has already signed something and the question is how does the investor get out of it without losing his shirt.
It is easier for Andrew to help you on the front end and protect you from a bad deal on the back end.
In many states, there are not specialties for attorneys and in some states it is illegal for an attorney to say they specialize in something.
However, there are many attorneys everyone knows that only do injury cases or the ones who do real estate transactions.
Within that, you will find attorneys who do hundreds of residential real estate transactions, but the moment you get into commercial transactions, they may not know what to do.
You need to think about what it is you are trying to do. For real estate investors, it is better to find someone who has broad real estate experience, as well as someone who has a litigation or business background.
You are marrying a lot of different legal realms and you need someone who is nimble.
The other option is to have a few attorneys that specialize in one thing. Andrew would rather work with one person.
When you to talk to an attorney, it is about getting someone on your team and vetting them like you would a contractor
It is similar to that. Attorneys are notorious for having terrible bedside manner, but that shouldn’t deter you.
Attorneys are like any other business. If they are not willing to talk to you, move on.
Andrew almost never sits face to face with his clients. He handles most communication through email, phone, or fax.
If an attorney is not willing to have a 15 minute conversation with you to figure out what your goals are, then you need to move on and keep interviewing.
How should we talk to lawyers to demystify it?
Think about it like you are talking to a doctor. You don’t want to get too much into the nitty gritty, you say this is what hurts and what should I do. You rely on the doctor to give you your options.
The same thing applies to lawyers. Andrew worked with a man who was doing remodels with cash and a handshake.
He moved into areas where he had bank notes drafted and notes between private investors.
He told Andrew that he has a guy who wants to give him money but he wants to make sure he doesn’t lose it. That is perfect for Andrew to figure out.
Go to an attorney and tell them what you are doing and have that kind of conversation.
Talk to your lawyer about your bigger goals, because it helps them understand where you are going.
You will be treated differently if it is a one-off deal than you would be if you are going to do this every six months. It will change what needs to happen.
Initially, you will probably be able to talk to an attorney for nothing. Most will give you 15 minutes for the initial conversation to figure out where you are going. If you are charged, it would be a nominal fee.
Once you start working with them, you will get a fee agreement and you should know what you are paying for and how much.
What should we talk to the attorney about, when we are first starting?
Anytime you get involved in any type of transaction, about 22 states, mostly on the east coast, require an attorney to close the deal. The rest require an escrow company.
Even in a state that doesn’t require an attorney to close on a transaction, Andrew recommends one.
You will have someone who is loyal to you.
You won’t have to worry if he is looking out for the other side. He is required by law to be committed to you.
For the individual transaction, you need to talk about what the contract says.
Don’t assume someone is going to tell you how it is done. If something doesn’t sound right, call your attorney and ask. Real estate deals are very contract driven and you need to know what the contract says.
Have your wishlist to make sure you know what you want out of the deal and talk to your attorney about it.
You are not going to bother your attorney if you have a lot of questions. Most transactions are done on a flat fee basis.
The questions on the individual transaction can be anything related to the contract, land use, title issues, zoning issues, etc. Those are all within the scope of what you should be talking about.
The other side is how to protect your assets, and this is where you get into business entities. Everybody’s situation is different.
Andrew’s general advice is when you first start out, the first couple of transactions is perfectly fine to do in your own name. Make sure you have good insurance and you trust your agent.
When you get to the next level, you need to think about how to protect your personal assets from your business.
You have a range of options:
- sole proprietorship
- S Corps
The LLC is the favored instrument and this is what Andrew typically suggests. They are simple to use and every jurisdiction has one. A big suggestion is to avoid partnerships.
There is no specific number, but when you have a couple hundred thousand dollars in assets, or several properties, or something is triggering that it is getting a little risky, you need to start thinking about an LLC.
Once your business is rolling, you need to get a little more sophisticated. You may need to be broken up into a few different LLCs, siloing to spread out your risk, and maybe involve a Trust to manage the LLCs.
This is setting up paper shields between potential liability and your personal assets.
The only thing that would be at risk would be the capital in that particular property.
This breaks the chain of ownership between you and the asset, which will prevent you from losing your personal residence and assets.
Magwood Law as well as other law groups handle all these transactions
Andrew does all of this. When he works with clients he has a meeting that lasts about an hour, and your spouse will be involved. At that point, he would take copious notes and the meeting is designed to be comprehensive.
He is going to take all of that information, plus the interview, and think through what the best plan is for the client.
He draws it out and has boxes that show you what LLC has what properties. You will have a visual so you can see it. You don’t need to know all of the legalese.
Then, there is another meeting where you go through and sign the documents and return everything.
The biggest issue is for you to be crystal clear on what you are doing. Don’t be afraid to ask questions, but ask them up front. You don’t have to understand exactly what the state laws are, but understand what you are doing.
Andrew likes working with other professionals too, like your accountant, to bring you solutions.
How to structure your business for protection from liability.
The right structure for you is probably an LLC, Limited Liability Company. Every state has an LLC. The LLC in many states can be a single member, in some states you need two members, but you could have a husband and wife. If you are married, you will probably be fine with an LLC.
When you start, you will also need an EIN, Employer Identification Number, so you can use that instead of your Social Security Number.
Then you will need a business bank account.
After that, we need to think about holding properties you already have in an LLC, which means transferring properties. When transferring properties, if they still have a mortgage, you will need to talk to the lender to make sure they don’t have a problem with you transferring the property.
If there is a due on sale clause, you may need to pay off the property note to transfer it.
Quickly tell us which LLC we would want to go with?
Andrew would personally go with a dual member LLC. If you are married and something happens to the operating spouse, it offers the other spouse easy access to transfer the properties.
If Dustin has a dual member LLC with his wife, and he died, she would be able to easily step in and manage things.
You really need to talk to your attorney and tax professional to see if it will make a difference with your taxes.
For taxes, it may make a difference to go with a single member versus a dual member LLC.
If you are not married and your state only allows dual member LLCs, shop for a jurisdiction that allows single member LLCs. Andrew dislikes having a non-interested party just for paperwork purposes.
Good States to incorporate your LLC
There is no problem buying properties in states other than the one your LLC is registered.
Disney is incorporated somewhere, but they operate parks all over the world. There may be a wrinkle with licensing and permits.
If you are a Wyoming LLC, you can hold properties in all 50 states and probably U.S. territories.
Have you run into a situation where someone had to register their LLC as a foreign LLC, because it was held in a different state?
Andrew cannot think of any state that requires it, except California is a little more strict than others.
Even though we use the term foreign, a foreign LLC is one that is formed in a different state than one you are in.
Registering them with the Secretary of State is a very state specific thing. Usually the test is if you are doing business within the state.
If you are merely holding property and collecting rent, you are probably not doing business for most states. The best thing to do would be to double check with the Secretary of State.
Is it okay to hold a property in my name and have really good insurance and move it into an LLC when my business gets bigger?
Even if you never had an LLC, the first thing you need is really good insurance. You need it to cover the structure itself, which is usually a given if you have a note. Specifically, you need to ask for a landlord policy.
You need to tell the tenants that your policy doesn’t cover their contents. Make sure your property manager tells your tenants.
You will also need a General Liability, GL, policy, as well as an umbrella policy with at least $1 million in coverage.
Should we have all of the properties under one LLC or should we split it up?
It depends on your specific situation and your risk tolerance. If you have multiple properties in your LLC and you are sued, every asset is available to recover and every property is at risk.
The Fraudulent Transfer Act prevents you from moving properties from an LLC after you’ve been sued. The court will undo the transfer if need be.
One strategy is to break up the properties into multiple LLCs. It is overkill to have every property in its own LLC, but it may be worthwhile if every property was worth $1 million. The more LLCs you have, the more complex your business and taxes become.
There is a term called piercing the corporate veil that means if I sue your LLC, in certain cases, I can go past the LLC and go to you personally and then turn around and go after LLC 1, 2, and 3.
If you’ve set them up properly, this shouldn’t happen but it is possible.
Andrew recommends finding a happy medium. If you have 20 or 30 properties, he recommends breaking them up into four, five or six LLCs of equal value.
Or, sit down and analyze properties of a certain risk, like older or more accident prone, and break those up.
If you have 20 or 30 properties, it would be a bad strategy to have them all in one LLC. Have a dollar amount you feel comfortable with for each LLC.
How do you protect against piercing the corporate veil, and what do you need to do create the LLC right?
You have to follow all of the corporate formalities. Some of those are state specific, but there are general things you need to do. Basically, do your paperwork every year, file your annual filings.
Some states require an actual annual meeting of the members. You can do those on paper and hold the documentation internally.
The formal part is an annual statement that is required that updates who the registered agent is and who the members are that needs to be registered with the state. It is usually a one-page form.
The informal part is the annual meeting. Keep minutes and make sure they are dated and signed. When you get sued, you don’t want to produce three years of minutes that were produced on the same day.
The law is not going to protect you personally, if you act like you and your company are one entity. The more you act like you and your company are one entity, the more the courts are going to say they shouldn’t protect you.
That looks like you paying your car note and gas bill out of your company bank account, not filing tax returns, and co-mingling your personal funds with your business funds.
You need to document it properly.
The more you treat the company like a separate entity, the better it will look.
Make sure you clearly document what you are doing. Think of your business/LLC as if you didn't own it, even though it is you personally signing.
Are there any other documents we need to have? Do we need to have an operating agreement?
Just like the annual filing, there is what is required by the state and what Andrew would require as your attorney.
The annual filing is usually one piece of paper and a filing fee. There is no requirement that you actually have an operating agreement or any kind of by-laws to legally have a business agreement.
However, if you do not have a personally crafted operating agreement, you are doing yourself no favors, because if you don’t have an operating agreement, it looks like you are not doing business.
The operating agreement is the future planning. It should have plans for death, divorce, and disability. You don’t want to have a corporate problem with your marital problem.
How does a spouse or someone else come in and manage the business if you die?
All of these things are important to get down early, because it will make the business look like a business.
Seventy percent of small businesses are sued. It happens.
Having these things in place make it look like you and your business are not one. It makes things functional when things go haywire.
How Should You Get Started Investing In Real Estate
- Start an Limited Liability Company (LLC)
- Get an EIN (Employer Identification Number) from the IRS
- Start a Bank Account
- Make sure you file your annual report to the state
- Hold an annual meeting with meeting minutes
- Have an Operating Agreement
Magwood Law Group: 12 Years In Business
Andrew has been an attorney for about 16 years. He had his own law firm for about 10 years.
He split his time, both in his practice and his life, between California and Connecticut. Now his office is in Connecticut.
He is licensed in both California and Connecticut, because you need to be licensed in the state you are practicing.
Any other state would need to be on a one-off deal. He works with people from all around the country, but he can only work primarily in California and Connecticut.
Andrew can set up LLCs and do estate planning in other states as needed.
How to Reach Andrew Magwood and Magwood Law
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