The Danger In Rentals
As a trial lawyer years back, I encountered dozens of horror stories from rental properties. While rental properties may have a place in your investment portfolio, they can be dangerous assets if not properly setup and managed. Phelps Law is located in Gilbert Arizona where we focus on estate planning and are able to help you avoid dangerous situations. The danger from property rentals stems from the fact that you have no control over the comings and goings on that property, and if a tenant or guest (or even a trespasser believe it or not) gets hurt, you might be on the hook! Here are a few liability situations I had to deal with back when I was a trial lawyer:
- Tenant throws a party at the house; 18 year old girl visits the party, dives into a 3 foot shallow pool, breaks her neck and is paralyzed.
- Tenant’s 16 year old boy is having a slumber party; one of the boys walks out the front door late at night to grab something from his car, stumbles face first into a sharp yucca plant that pierces his eye. He is now blind in that eye.
- Tenant’s dog attacks a young child and causes permanent injury and scarring to the child.
There are dozens of stories like these, and with limited control over what happens at a rental property, you as the landlord need to be well protected.
Ways to be Protected from Rental Properties
Your entire personal wealth can be exposed to liability claims when the rental property is titled in your personal name or in the name of your Living Trust. If a lawsuit occurs and the rental property is titled in your personal name or the name of your Living Trust, everything owned by you and your Living Trust is in jeopardy.
How Do I Protect Myself Then?
Step 1: Have a good insurance policy. Insurance is always the first line of defense. Having a good homeowner/landlord policy, and maybe an umbrella policy to increase your coverage limit will be very beneficial. However, pay attention to your policy, as insurance policies have liability limits which may be exceeded by a serious claim. Insurance policies also have coverage limitations that exclude particular claims, and you need to understand exactly what those limitations are. Read your policy carefully, and talk to your agent about whether your coverage is adequate.
Step 2: Increase your protection by forming an Arizona limited liability company (“LLC”) to own the property. Creating and maintaining an LLC is a surprisingly simple process when done right. You want full documentation to make sure it holds up in court, and it can be set up so you don’t need to file a separate tax return. An LLC that is properly formed and operated isolates dangerous rental properties from all other assets. If a lawsuit is filed by a tenant, guest, or anybody else who gets hurt on the property, the only assets the creditor can reach are those that the LLC owns (i.e., the property itself), and not your personal residence, bank accounts, and everything else you own outside the LLC. Oftentimes, my clients place each rental property in its own separate LLC to spread out the liability risk. Also, the LLC should be structured to coordinate with your revocable living trust to avoid probate and to allow your successor trustees to step in and manage the LLC business if you become incapacitated or die.
LLCs as a Practical Solution
We always tell our clients that when it comes to protecting from the unknowns, such as lawsuits, nothing is a 100% guarantee. But in our experience, LLCs are the most practical solution to put a layer of protection around your dangerous rental properties. They are easy to maintain and are very flexible as to how they are taxed. But it is important to have them set up by someone with the right experience who can provide all the right documentation, including a well-drafted Operating Agreement, and more importantly counsel you on how to avoid all the traps in the ongoing management of the LLC.
Phelps Law Can Help
Here at Phelps Law we have helped our clients form hundreds and hundreds of LLCs over the years and would be glad to sit down with you to discuss whether an LLC makes sense in your particular situation. So drop us a note or give us a call if you would like to schedule a time to meet.
Images used under creative commons license – commercial use (7/19/2017) a rancid amoeba (Flickr)