“Six Secrets of How Wealthy Landowners Protect Themselves From Lawsuits”

I recently read that a lawsuit is filed every 13 minutes of every working day in California and this disease is proliferating throughout the country.

In addition, the toxic substance and mold litigation is on a rise with multi-million dollar verdicts against the landowners.

Over 80 million lawsuits are filed each year in the U.S. Each year trial attorneys create new causes of action aimed at the perceived deep pockets of businesses and individuals. For instance, most people are familiar with the infamous McDonald’s hot coffee case and lately, the mold cases. The San Francisco Chronicle reported on January 22, 2003, that tenants of an apartment building in Hayward are suing the owner for five million dollars for mold related injuries. Mold damage awards in recent cases have been so great that the major property insurance companies are reluctant to write policies in California. It may be a limitation or exclusion in your policy.

Mistake Number One – Not understanding the implications of how you own your real property.

The inexperienced landowner holds all their property as themselves, jointly, or as “joint tenants”. In some cases this can work, but in many cases it can be the cause of an expensive and devastating mistake.

With the proliferation of mold cases mounting, it is a best practice to not hold investment property in your own name because insurance will not cover these claims.

The wealthy and experienced real estate investor knows that they have to use a limited liability entity to hold the property creating a prophylactic between themselves and any liabilities stemming from the property.

Mistake Number Two – Not knowing which estate-planning document to use so you’ll avoid lawsuits

Should I use a revocable or irrevocable trust and should it be domestic or foreign?

A lot of folks don’t know that a revocable trust is only for avoiding probate but offers no creditor protection.

Depending on timing when a person is sued, there are great opportunities with the right irrevocable domestic trust. On the other hand, there are some really great offshore solutions that allow you to participate in the global equity markets and are experiencing much higher gains than the U.S. market.

There is also one super investment tool that is protected and avoids capital gains providing far better returns than mutual funds and independent stock investments.

The experienced real estate investor knows that they should put their home into a plan that will not affect their tax benefits but still render solid protection from a creditor by using the right tool.

Mistake Number Three – Holding Too Much Equity in Your Home.

If a creditor can’t get at cash, they go after real estate. The best place to start is with the roof over your head. Most states are experiencing record appreciation which means there is a lot of equity in many homes.

But how much interest is this equity earning? There are products where you could be investing some of the equity proceeds and earning more than you’re paying for the loan. The wealth minded landowner leverages everything, earns on that leverage and tries to reduce ownership.

Some superior mortgage products are on the market that will keep your equity down while you live in the home. At first blush, it sounds contrary to common thinking. Nonetheless, the wealthy person puts everything at their disposal to work to create extraordinary wealth, even home equity.

Doesn’t it make more sense to tie the money up in investments that earn and keep your home safe?

Mistake Number Four – Not Keeping Adequate Property Insurance

A good insurance policy can provide a solid first line of defense. However, you must be aware of its limitations.

General business insurance policies insure against accidents on the business property such as slip and falls and fire and equipment malfunction. These policies often exclude accidents occurring outside the scope of employment, an intentional act by an owner or employee, contract claims and working at home.

Liability policies for professionals such as doctors, dentists, attorneys, architects, engineers and accountants also have exclusions from coverage such as grossly negligent acts, willful or wanton misconduct, punitive damages and liability related to product liability.

Personal liability insurance policies include auto, homeowners and umbrella coverage. If a plaintiff’s damages exceed your auto policy limits, you will be personally liable for the balance. Homeowner’s insurance policies provide insurance for damage to the residence caused by acts of God, insects and often construction defects. The policies often exclude coverage for any business activities at the home. Umbrella insurance policies are a relatively inexpensive way to supplement auto and homeowners policy limits, but they are not complete. Umbrella policies generally exclude coverage for dangerous sports, dangerous equipment such as guns, trampolines, swimming pools and sometimes lawn mowers, chain saws and power tools. In addition, such policies may exclude dog bites, intentional acts and business activities.

Another problem with relying exclusively on insurance is the risk that your insurance company may not be in business when you file a claim. The Wall Street Journal reported on January 30, 2003, that a rash of insolvencies among insurers is resulting in hundreds of thousands of consumers at risk of not collecting on their claims. The problem is growing as more and more insurance companies are filing for bankruptcy.

While insurance is a good first step, it not always reliable. The experienced real estate investor never relies on one tool but uses all tools in their tool belt to protect themselves.

Mistake Number Five- Not Avoiding Probate

Multiple Probates. If you have real property in multiple states, then you will have to probate the property in each state.  That means attorney fees in each state, potentially larger probate fees in other states, and the administrative burden of multiple state probates. The average is 3% to 8% of the gross estate, if you compound this by five or more states your estate is in trouble.

Along with protective features, a good plan should tie into your estate plan so that you avoid multiple probates. Our office and the tools we use on a daily basis to take care of clients can accomplish this very easily.

Mistake Number Six - Procrastinating

This is likely the biggest and most costly mistake the novice real property investor makes. The wealthy real property investor always takes out time to do proper planning because the alternative could be catastrophic.

If you want to avoid these outcomes, you need to take a little bit of time out of your schedule and plan.

The truth is with proper planning almost anyone can dramatically improve their estate, business and retirement plan.

Due to the complexities of estate preservation planning (“Asset Protection”) and the many changes slated to occur, it’s extremely difficult to explain each application of these strategies here in print.

While one client may be able to benefit from a strategy by using it one way, another client may be able to benefit from a different application of the same strategy. Everyone’s situation is like a snowflake, no two are alike.

If any of these strategies make as much sense to you as they have for America’s wealthiest landowners, then we invite you to contact us for more information on how to do the same.

You can also find out more by reading the “The 3 Secret Pillars of Wealth” which is sold at Amazon, Barnes & Noble, Borders and other fine book stores.

James Burns, Esq.

www.jamesgburns.com

TAX REDUCTION AND ASSET PROTECTION FOR REAL PROPERTY

The most intimidating concern of real estate investors is how do I protect my property, reduce taxes and what entity if any should I use? First, you must have a very good tax and legal team who understands real estate and investors.

If you are an investor who does rehabs, fixer uppers, option contracts, developments, consulting and services or you are a real estate agent or broker you are facing self-employment tax which is upsetting. The rate is 15.3% which is the difference of the 7.65% that an employer withholds for social security and Medicare and then matches. As a self-employed individual, you receive no match and pay the entire 15.3%.

If you’re paying elevated self-employment tax, you are a sole proprietor. Often a client can optimize their situation by using an entity but which one will do the trick? By now you’ve probably been racking your brains on this very question and heard of the C-corp., S-corp., Limited Liability Company (LLC), and Family Limited Partnership (FLP). The C-corporation is sometimes effective by typically not a good fit for most because it creates a double taxation. The S-corp is generally best for a company raising capital or going public. However, sometimes a C Corporation may be appropriate for other operations because its initial tax brackets of 15% and 25%.  For example, if you’re in an individual tax bracket of 25% or higher, then there could be an opportunity to eliminate taxes by shifting some of your income to a C Corporation. This has a nice application because of the shifting of income to a taxpayer (your C Corporation for instance) in a lower tax bracket than you personally.

The S-corporation makes great sense for those who are doing consulting, rehabbing, fix & flips, developments and services because it is a flow through entity. Because of this flow-through capability there is no capital gains tax and no dividend tax but you have to take a “reasonable salary” and create a payroll which is probably the biggest intricacy. There are no hard and fast rules on the salary and is a subjective analysis. My team and I have devised a spit that is prudent, yet reduces tax. This salary/dividend split is the number one strategy for ordinary income. Remember when dealing with real estate investing we may have passive or ordinary income and for each type of income there will be a different strategy that in combination, slays some of the tax and provides protection.

Some of the difficulties with the S-corp. if you want to really nitpick are, it is inflexible in moving long-term real estate in and out and you have to do a quarterly payroll. The payroll is simple to deploy but you need to find a cost-effective tax preparer who will do it or use a payroll company and it should not cost an arm and a leg to get done but the savings will substantially offset this expense. A good rule of thumb on when it makes sense to have an S-corp is around $50,000 or more of ordinary income.

If you’re not doing anything but buying and holding then you’ll want to consider a limited liability company (LLC). You will not get the abatement in self-employment tax but you have liability protection and an opportunity to do some creative estate planning to avoid future estate taxes. Owning a small business for rental real estate is an excellent strategy since it may convert personal expenses to business expenses that will offset income even if you are currently an employee receiving a W-2 from an employer. The LLC also limits a creditor to a charging order which is an assignment of income and many LLCs do not distribute or can elect to not distribute thereby making this a hopeless remedy for the creditor. Contrariwise, a limited partnership can be foreclosed upon by statute in California.

Sometimes clients are told to use an LLC and have their S-corporation be the general partner of their family limited partnership (FLP) and this can create vulnerabilities to the stock of that S-corporation by a lawsuit that occurs outside of the LLC activities. The strongest portfolios seem to be those that have a combination of active real estate investing e.g., fix & flips, rehab, and passive in the form of rental real estate which can then be used to offset income of the active investing, however, this requires use of two entities.

In closing, clients are often confused where the best place is to set up there entity because they hear all the radio ads about Nevada. If you are a resident of California, you will not save any taxes by forming your entity out of the state. There other states that have stronger protection (e.g. Delaware) and under the Supreme Court Doctrine of the Internal Affairs, a corporation will be governed by the state of incorporation but any disputes arising will have the law of the jurisdiction where the dispute occurs applied. For example, if you are incorporated in Delaware and hold Texas property and encounter a challenge in Texas, Texas law will be applied but how the corporation is run and its structure should be preserved under the state of incorporation which would be Delaware.

If you have any questions about setting up your real estate investing business you need to find a great team for the tax and legal strategies. The best is usually an attorney and CPA who are also investors and understand the merits of owning real estate. This is only a broad brush stoke on the possibilities and each persons circumstances are different so you would need to be evaluated, as one size does not fit all.

Happy investing,

James Burns, Esq.