I am not an attorney and this is not intended to be legal advice. I am a licensed real estate broker and property investor offering only general advice. For specific help for your personal investment strategy, please seek the guidance of an attorney in your area..
Every property investor’s nightmare situation is getting sued. For some, the potential of getting sued is enough of a reason to not get involved. Like all great endeavors worth taking on, there will be risk. Thankfully there are ways to protect yourself and to mitigate such risk. Proper liability protection measures can keep you from having to reach into your pockets if something unfortunate should arise.”
The first and most common form of liability protection is something that everyone is already familiar with, insurance. You have insurance on your home now if you currently reside there. It’s used to protect both the asset itself and to protect you if there should be an accident on your property.
The concept is very similar in an investment property only that you will seek slightly different insurance. The type of insurance that you have on a rental property differs in that it does not cover the personal property of the tenants. It will continue to cover the building, any property of yours that remains inside like appliances, cabinets, and other parts of the home not considered the building itself. It will also provide you with medical coverage protection should there be an accident. Rental income will also be covered as you would normally receive if there should be a catastrophe at the property.
Be sure to specifically tell your insurance agent that you are now using the home as a rental property prior to the tenants moving in so that they can adjust your insurance to properly protect you. You will not be fine to just keep what you have. There are generally loopholes and ways to exclude you from coverage if a claim arises later and the occupancy is not quoted as a part of the policy.
LEGAL LIABILITY COMPANY
The second step to protecting yourself is to incorporate. Most investors consider a Limited Liability Company (LLC) to be the best way to hold your investment property. There are a number of other options such as an S-corp, C-corp, limited partnership, and more. The reason that most people prefer an LLC is for tax purposes. It is considered a pass through entity for a single owner LLC.
This means you are not required to do a business tax return, but rather pass the income and expenses to your personal return on a Schedule E. This will save you on tax preparation fees and simplify matters. The other advantage of an LLC is that it does not have the board meeting requirements of a corporation and offers the ultimate in flexibility for set up. You can have more than one owner and can choose how the income and expenses are shared with great flexibility.
Whereas in a corporation (such as an S Corp or C Corp), shares are issued and all things must be divided by the number of shares one owns. Also, it is important to note for tax purposes that generally a married couple is considered one person in an LLC. This also indicates that there is no need for a partnership agreement or lengthy member control agreements.