Turn the buyer into a limited liability company

Editor’s note: This article has been corrected from its original version to reflect State Farm’s policy regarding insurance coverage for dog owners.

If you are working with a couple who are interested in buying a second home as an investment property, you may suggest that they discuss the establishment of a limited liability company or other legal entity with a lawyer before purchasing. In this way, if someone sues them on the property after buying a house, they can limit the loss and protect personal assets from loss.

Suppose that the contractor they hired neglected to repair the deck, and it collapsed while the tenants and guests were grilling. In this case, the judgment may easily exceed the owner’s rights and interests in the property and even exceed the coverage of his insurance policy.

Or, they rent the property to someone who has a dog that is not covered by a typical landlord’s insurance policy, and the dog bites on the property. For example, state farms determine risk based on a dog’s bite history rather than its breed. The company paid US$121 million in dog bite claims in 2016, an average of US$33,000 per claim. The amount of the claim may exceed the property rights owned by the homeowner. This may make their personal assets vulnerable to the judgment.

In other words, the carbon monoxide detector is faulty. The furnace of the property has a history of 20 years. It will crack and release gas into the room. Unfortunately, a family of four was killed. The owner may face four wrongful death lawsuits due to negligence.

Severity of risk To be sure, these situations are rare, but they point to serious risks that investment property owners may face. In fact, these scenarios illustrate one of the main differences between real estate and other types of investments such as stocks or bonds: real estate may take more risks than investments in assets. Of course, the owner’s first layer of protection is insurance, but the owner may not realize that their losses may exceed the insurance coverage. Or, there may be exceptions or exceptions within the coverage that exclude or limit the loss. These gaps in coverage may impose unlimited liability on the owner. In today’s litigation world, liability insurance of US$100,000, US$300,000 or even US$500,000 may be insufficient. In addition, owners who convert their homes into investment properties may not consider buying a landlord or vacant property.

In order to obtain appropriate protection, purchasers should strongly consider a personal liability protection policy with coverage ranging from US$1 million to US$2 million. But they should also consider forming and operating a company or limited liability company. The types of entities they can form vary and are governed by state laws, but almost all states allow the establishment of legal entities such as limited liability companies, partnerships, C companies, and S subsidiaries. Pricing considerations Deciding which type of entity to establish and how to structure the entity should be made under the advice of legal counsel. The process may not be expensive. Depending on the size and particularity of the family, legal work can cost hundreds of dollars. There are also do-it-yourself forms on the Internet, but self-service is not recommended; these entities, whether it is your own investment or your client’s, must be set up correctly for maximum protection.

Investing in real estate may be a wise decision. The right property can outperform other investment tools. However, since real estate investment has potential pitfalls, it is reasonable to have adequate insurance, and investors may consider setting up a limited liability company or other types of entities to separate their liabilities from personal assets.