Every serious real estate investor reaches a point where they start to worry about being sued and having all of their hard-earned investments taken away by an ambulance chasing attorney and scheming tenant.
The first step many take is creating a limited liability company (LLC), which are easy and cheap to create, and which once upon a time may have actually, you know, limited someone’s liability in a lawsuit. The theory went that you created an LLC, and owned a rental property or two under its name, so that if the worst happened and you were sued, only the LLC’s assets could be taken. So, your other LLCs’ assets were safe from the lawsuit, as were your personal assets (your house, your car, your engagement ring, etc). If you owned five rental properties, and each rental property was owned by a different LLC, then you had supposedly isolated each property’s liability so that the most a plaintiff could take was that rental property, not your other investments and certainly not your personal assets.
Most asset protection attorneys agree that those days have passed. When a tenant sues you today, they simply name both your LLC and you personally in the lawsuit. It’s known in attorney-speak as “piercing the corporate veil”, and it’s appallingly easy to do and allowed by the courts. (Aside: legislators and courts don’t like the practice of “asset protection”, because civil law only works if plaintiffs can actually win assets, if the court rules in their favor.)
So what’s the point of using LLCs, and why do many asset protection experts still sometimes recommend them?
Some people contend that there are tax and accounting benefits to using LLCs. This can be true, depending on how you organize and file your taxes.
A common line of reasoning is that good asset protection is about layering as many barriers between yourself and your assets as possible, to make it difficult for bottom-feeders to sue you and take your assets. Is it easier to sue Margaret, whose name is on the deed of her rental property, or ABC Rental Holdings LLC, which is owned by a Nevada corporation, which is in turn held by a Delaware company, which is in turn owned by an overseas subsidiary of an anonymous legal entity? Digging through all that to find Margaret’s identity might be difficult, and finding her other (similarly obscured) assets would be even harder.
But here’s the rub: all of that spy-thriller stuff above is awfully expensive, and a giant pain in the rear to set up and manage. Just paying the annual renewal fee of one LLC costs $150-400/year, not to mention all the other companies listed above. And what about the setup costs for all those companies, some of which are out of state, and maybe even international? Lastly, think about the colossal attorney fees that the slick mastermind attorney will charge you, and you quickly realize that it sounds awfully impractical for the average rental property.
Enter: the Delaware Series LLC.
If Margaret owns five rental properties, then instead of creating an LLC for each of them, and having to pay the hefty renewal fees each year, she can set up one Delaware Series LLC, and just create a separate “series” or “cell” for owning each property. Each cell serves as its own separate legal entity, and is theoretically distinct from the other cells, and from the owner. For accounting and tax purposes, this will achieve similar results as setting up and maintaining five different LLCs, but at a fifth of the cost.
Of course, this suffers from similar risks as just using an LLC however, with the possibility that a litigious tenant and their attorney will simply pierce the corporate veil and sue you personally alongside your LLC cell. But there is another advantage to Delaware Series LLCs over other states’ LLCs: Delaware does not require your personal name to appear on the paperwork when you create the LLC. Thus, your name does not have to appear on any public records of the LLC itself, providing some anonymity.
You do need to maintain a “registered agent” in Delaware, a person designated as an in-state representative of the LLC, who can be served with lawsuit paperwork. They also must by law keep records of your identity, so they can be subpoenaed to reveal your name and address, but this is still a second layer in between your identity and the property ownership.
From there, you can potentially add more layers, or get fancy with irrevocable living trusts and other legal maneuvers, depending on your net worth and perceived risk of being sued. But for $300/year in renewal fees, and $50/year in registered agent fees, you can put the first two layers in place between yourself and all of your rental properties – no matter how many that is.
Before running off and filing a series LLC however, understand that they are untested in many states’ courts. There are even less guarantees with series LLCs than with more typical approaches to asset protection, which are already mercurial and never certain to work.
One last word on asset protection for rental properties: the simplest (albeit still costly) approach is to just take out the largest possible mortgage on your rental properties upon purchasing them. What’s the point of suing someone who’s so leveraged that there is no equity to take? The plaintiff could force the sale of your property to try and collect on their judgment, but the mortgage would be paid first, making the plaintiff's lien worthless if there is no equity in the property. This won’t stop them from taking other personal assets of yours, such as your stock portfolio, but they may think twice before suing you if they look up the property’s public records and find a massive mortgage.