Rental Properties
Texas real estate investors have a variety of concerns when purchasing real estate for investment. One of the main concerns (aside from tax liability) is how to avoid legal liability with rental properties. Nothing worries an investor more than a litigious tenant or licensee of a tenant that slips and falls and sues the landlord. While there are a multitude of factors that need to considered before landlord liability attaches (beyond the scope of this blog article), a landlord with multiple assets seeks to isolate and protect their assets from lawsuits, frivolous or not. It is safe to assume that all persons with any transaction with the rental property may have a legitimate claim against the landowner. Thus, the landowner seeks asset protection and sometimes looks to the internet for fill in the blank forms or real estate gurus with their proprietary asset protection systems that fail to consider the unique Property Code and Business Organizations Code of Texas.
While there can be several entity structures to be used such as limited partnerships, corporations, holding companies, Hub-Sub Structures, mixing LLC’s from different states, mixing trusts with LLCs, using trusts, and traditional LLC’s for every asset, we will be looking at a modified Two-Company Structure. Traditionally, it was recommended that investors have their rental assets in a holding company (traditional LLC) while maintaining a different LLC that handled the management side of the rental assets. This would insulate the assets from potential liability from lawsuits. As a side note, it’s always recommended that you have sufficient insurance to cover possible claims in your fact-specific scenario. As the adage says, an ounce of prevention is worth a pound of cure. Insurance plays an essential role in minimizing your risk as an investor.
While taking the approach of separating your activities from the rental assets, your assets should be held in a series LLC with little to no public business interactions. This ensures that your exposure to lawsuits is minimized because there will be virtually no legal privity in connection with any opposing party to withstand a successful lawsuit. No privity of contract means no standing from your tenant, contractors, vendors, etc. All of these transactions should be handled by your management “shell” company. An investor can also consider purchasing the rental asset with the management company, process all transactions of the closing and rehab before transferring to your series LLC. This will secure anonymity in the long run since your holding series LLC will have little public-facing interactions. This approach is for the serious investor looking to obtain and maintain several rental properties and places a premium in maximizing their asset protection. Smaller investors should stick with the traditional two company structure for ease of use and administration.
So what is a series LLC? This is a limited liability company that is allowed to have more than one separate series of members, managers, LLC company interests with independent rights, duties, and liabilities. This means that each series can have a different liability exposure to the other series in the LLC. For example, House 1 (300,000.00 Value) is purchased and transferred to Series A, and House 2 (1,000,000.00 Value) is purchased and transferred to Series B. Under a plain one company series LLC structure, if the tenant in Series A sues the landlord and wins, he may only recover the assets in Series A. The litigious tenant can’t go after the Series B million dollar home. Under the modified two structure company, it is even harder to get to the investor’s assets, which is why it is preferable. Stay tuned for further discussion and details on setting up a series LLC.
Disclaimer: This is not intended to be legal advice and is solely meant for educational purposes. Reading this article does not establish a lawyer-client relationship. This firm does not represent the reader unless there is an express written contract. Laws change and you should consult an attorney before making any decisions that may have legal consequences based on your specific needs and circumstances.