I generally see two types of landlords: investors who desire to diversify their assets with real estate by owning several rental properties and investors who moved and opted to rent their old home rather than sell it. Regardless of how you entered into real estate, liability exposure is still a concern.
As a landlord, you can be held responsible for injuries incurred on the rented premises, injuries or damage that are caused by animals that your tenants own, and even unlawful conduct of your tenants, among many other perils. In contrast, your stock investments generally do not expose you to such liability claims. No one is going to sue you for slipping and falling at a restaurant if you own McDonald’s stock. But if someone were to slip and fall on your rental property, your assets — like your McDonald’s stock — could be at risk.
While most financial advisers are not lawyers, your adviser is still a good place to start when you are concerned about your liability, as he or she often understands how your other assets are titled, where they are held, and what might be at risk. Generally, individual retirement accounts, 401(k)s, and other types of tax-deferred retirement accounts can shield your assets in case of a lawsuit.
If the majority of your assets are in retirement accounts, it may be more efficient to protect yourself from excess liability claims with an umbrella policy, which is a specialized policy to help cover costs that go above your standard insurance policy’s liability limits. This can be a cost-effective way to minimize the risk that comes with owning a rental property. I often see umbrella policies used by younger investors who may have married and opted to rent one spouse’s former home. If you decide to cover your liability with an umbrella policy, you may also consider having the spouse with fewer assets hold the title in his or her name only while the other spouse holds that title to the family home.
Now, if you own multiple rental properties, I often recommend using a limited liability company to hold your real estate. An LLC is also ideal for those investors who own their own business or have brokerage accounts with other investments. The more assets an investor and his family own, the more important it becomes to protect against this liability.
When you establish an LLC, you can effectively limit your liability to the assets owned within the LLC. Your worst-case scenario is that the LLC is sued and forced to declare bankruptcy, and you lose the rental property. Your other investments, retirement, wages, home, and cars are all protected. Furthermore, with multiple rental properties, your lawyer may recommend separate LLCs for each property to protect your other properties from a lawsuit.
However, before you create an LLC for your rental property, it would be prudent to discuss your plans with your financial adviser and your lawyer. You need to be aware of the ongoing costs and annual filings for an LLC, and your current mortgage on the property may prohibit you from transferring the title. Even with the potential drawbacks, an LLC is still one of the best ways to protect your personal assets from a lawsuit stemming from your rental properties.