LLC – Limited Liability Company
When considering what asset protection strategies are effective for your short-term rental and other real estate investing, you must first identify the types of assets you own: no risk, low risk or high risk. No risk assets can include your personal residence (if you reside in a state that provides homestead protection for your primary residence), insurance policies, etc. Low risk assets may include your retirement accounts, brokerage accounts, etc. Finally, high-risk assets include short term rental investments, long-term rental investments, multi-family investments and other real estate investments.
Limited Liability Company (LLC) entities can be an effective tool in asset protection for short-term rentals and other real estate investments. The real question is not whether they should be used, the question is how they should be used to effectively protect your assets.
The protection provided with an LLC structure is provided through charging orders drafted by your asset protection lawyer. LLC charging orders are drafted as part of your LLC structure in order to provide a separation between you individually and the business of the LLC. If the charging orders are drafted properly, they will help to limit damages inflicted by a creditor or personal injury attorney for a premises liability event that might occur at your short-term rental property.
For example, if you have a short-term rental property on a lake and someone dives from your boat dock and seriously injures themselves, you could be the subject of a costly lawsuit. If you do not have your property in an entity for protection, your entire net worth could be subject to attack in the lawsuit.
When drafting an LLC as part of your short-term rental protection strategy, it is important to have a strategy for how you use this legal entity. Some attorneys will draft LLC’s and place all of their clients’ high-risk assets in a single LLC. This is a risky proposition! What happens if a lawsuit originates out of a short-term rental asset and the short-term rental is grouped with other assets in a single LLC? You stand to potentially lose all the assets in the LLC if you are sued! Why? Because any assets owned by an LLC become vulnerable to attack if a creditor or attorney is able to pierce the veil of the LLC.
Depending upon your specific situation, it can be effective to place each short-term rental property (or other real estate) in its own LLC to isolate it from attack from other high-risk assets. In other words, by placing your property in its own LLC, it protects it from attack in the event one of your other properties is sued.
Does It Matter Which State You Set Up Your LLC?
Many people believe that you can achieve asset protection nirvana by merely setting up your LLC in the right state. Unfortunately, that is not true. A frequent practice amongst investors is to chase favorable state laws regarding LLCs in the belief that it will shield them from a lawsuit or creditor.
For example, many investors will look to a Wyoming LLC, Nevada LLC, or Delaware LLC to establish their short-term rental asset protection because these states have favorable laws for LLC’s. Here is the problem – what if your short-term rental is located in Texas and you set up a Wyoming LLC to obtain ownership of the property? Do you get to obtain the benefit of Wyoming’s laws even though your STR is located in Texas? NO!
Generally speaking, the laws of the state for which your short-term rental is located will be controlling during a lawsuit. Think about it – if you are sued for actions arising out of a Texas property, you will be brought into a Texas court and required to answer to a Texas judge. A Texas court is very unlikely to find a jurisdictional connection between a Texas short term rental property and Wyoming laws. In fact, most competent personal injury attorneys will argue that your LLC is not a legitimate business and was only set up for asset protection.
In summary, chasing favorable state laws by setting up LLCs in a state where the asset is not located, is likely going to be an unsuccessful asset protection strategy and may cause you unnecessary administrative and tax consequences.
Can I Set Up An LLC That Makes Me Anonymous And Protected From Attack?
A common misconception many investors have is that they can set up a Wyoming LLC and it will provide total protection from a lawsuit. Why? Because people believe a Wyoming LLC will render their assets anonymous, thereby providing a shield to liability in a lawsuit. Be careful! While it is true that Wyoming LLC entities do provide privacy, it would be a mistake to believe they provide anonymity.
Here is how it works – Let us pretend you have been sued for negligence because of an accident at a short-term rental property (Airbnb or VRBO) you own in Florida. You have set up a Wyoming LLC in the belief that you will be anonymous to a predatory attack by a lawyer. If an attorney sues you, he will have papers served upon your registered agent. Your registered agent will provide you these papers and you will be required to appear in court because you were designated as a member or manager on your LLC paperwork. When you get to court, you will be placed under oath by the attorneys and required to answer regarding your ownership interest in the LLC and the short-term rental.
As you can see, there is no anonymity if you are sued and hauled into court. However, we do not discount the value of privacy. Wyoming LLC’s can be effective in making yourself a smaller target by those looking to bring frivolous lawsuits. It is important to understand the distinction between privacy and anonymity!
Limitations Of An LLC For Asset Protection
Although LLC’s have their place in an effective asset protection strategy with short term rentals and other real estate investments, it is important to consider the limitations of an LLC. We will address some common pitfalls real estate investors fall prey to when managing their properties in an LLC.
First, do you know if your short-term rental LLC was set up as a disregarded entity? Beware the disregarded entity when it comes to asset protection! Most real estate investors have no idea if their LLC was set up as a disregarded entity. If your LLC was set up as a single member LLC, you are likely considered a disregard entity. Why does this matter?
Although being labeled a disregarded entity is favorable for tax purposes, an attacking attorney against your LLC attempt to pierce the veil of your LLC by arguing that setting up your LLC as a disregarded entity was done purely for asset protection and not for legitimate business purposes.
Remember, what matters is how the courts will interpret your LLC. Far too many courts in the United States are quick to pierce the veil of an LLC if they believe the LLC was set up purely for asset protection and not for the operation of a legitimate business.
Secondly, what happens if you do not follow the company formalities required by law for an LLC? In other words, what if you do not hold an annual meeting? What if you did not keep the minutes or maintain records of your LLC? What if you comingled funds from accounts between personal and LLC funds? This happens frequently with short term rental investors that are busy self-managing their properties.
Maybe you are standing at the store, and you find a perfect accessory that will work at your STR, but you only have your personal credit card on you, so you buy it and reimburse yourself later. This may seem like a simple and innocent concern, but a skilled trial lawyer will argue the comingling of funds between person and LLC assets creates a legitimate basis to pierce the veil and gain access to the equity you have in your short-term rental property. One of the easiest ways to lose the protection of an LLC is bad management and bad accounting practices!
What Role Does An LLC Have In A Short-Term Rental Protection Strategy?
Every situation is unique! However, generally speaking, each short-term rental property should be owned by its own LLC to prove separation of assets. By separating each asset into its own LLC, you provide entry-level protection for your property without putting other assets at risk in the event of a lawsuit or creditor action.
What about the concerns regarding the limitations of the LLC? These issues can be addressed by establishing a holding company to own all of your high-risk assets (each STR within an LLC). We recommend a Limited Partnership structure. Because you will have a holding company owning all of your short-term rentals, you do not have to concern yourself with whether your LLC is a disregarded entity. We will discuss these benefits more in our conversation regarding the protections of a Limited Partnership as your holding company.
Although LLC’s have limitations, they play a critical role in asset protection with your short-term rentals. They work well as a smoke screen and a financial deterrent for predatory attorneys looking to bring frivolous lawsuits. Do not waste your time chasing charging order protections and be careful when trying to buy protection from another state’s laws when your Airbnb or VRBO is located in a different state. Remember, it is important to layer your protection to make it more expensive and difficult for an attorney to attack your wealth. By taking these proactive measures, you make it less likely that you will become the target of a lawsuit in the future!