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An Ounce of Prevention (and Proper Planning) Can Offset a Pound or More of Liability

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Published: 04Jun2009
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Recently I had two different sets of clients come in to me with major legal problems. As you will be able to perceive after reading this article, these problems could have been drastically mitigated or even eliminated with proper planning and implementation.

The first clients, whom we will call Jim and Donna Smith, were an elderly couple who years before had saved enough money to buy a duplex in the Southern California area which generated rental income for the couple. The title to the duplex was originally in their own name, but when Jim and Donna did their Estate Planning, they re-titled the duplex into the name of the Jim and Donna Smith Family Trust so that they could avoid Probate and have the assets distributed to their children according to the instructions of the Trust.

They had a reasonable amount of liability insurance on the duplex. However, there was always a fear lurking in the background that they didn't have enough protection and that if something happened at the duplex, not only would the duplex property itself be in danger, but their other personal assets would also be exposed.

Well, sure enough, calamity did strike. There was a major accident at the property and a guest of one of the tenants was killed. The victim's estate sued for millions of dollars and included Jim and Donna in the lawsuit as the owners of the property (their Living Trust avoided Probate, but did not provide protection against creditors). Certain parts of the victim's claims turned out not to be covered by the insurance policy. Moreover, the claims were in excess of the policy limits. Lo and behold, not only were Jim and Donna faced with losing the duplex property itself, but also their residence and other assets for which they had worked so many years to build up and pay.

What could Jim and Donna have done to prevent this catastrophe? The very first basic step would be to create a limited liability company ("LLC") into which they would place the duplex property. A limited liability company is like a partnership or proprietorship for tax purposes, but it has a shield of liability similar to a corporation that protects the owners of the LLC from personal liability. If Jim and Donna had set up this simple liability protected entity, their personal assets would not have been exposed to the victim's claims. The victim would have been able to go against the duplex property itself, but not Jim and Donna's residence and other personal assets.

We had another client who came to see us who owned some unimproved property up in a recreational mountain area of Southern California. Because there was no activity on the property, the client had no liability insurance on it. Unfortunately, some young boys decided to play "Army" on the property and one of the boys was severely injured when he fell out of a tree. Our client who owned the property was sued for several million dollars by the boy and his parents. Although he did not have assets worth the total amount of the claims, he did have at least two million dollars in personal assets and was thus a very attractive target. The property itself was only worth $150,000. If the client had set up an LLC and re-titled the unimproved lot into the name of the LLC in the proper manner, the boy and his parents would have only been able to go against the property itself and not against the rest of the individual assets of our client.

The lesson to be learned from these and many other experiences is that real estate investments (other than your personal residence) need to be placed in a liability protected entity like a limited liability company. The risks are too great to take a chance for personal exposure above and beyond the value of the property. The set up of a limited liability company is at least the threshold step that should be taken for the protection of personal assets when real property is involved. There are other more sophisticated steps that can provide further protection, but the limited liability company for real estate investment is a very basic and elementary first step that must be taken for adequate protection of your other personal assets.

Jeffrey R. Matsen of Wealth Strategies Counsel helps people structure their personal and business assets in the best way possible to protect, preserve and transfer them in the most efficient and tax saving manner. For more information go to http://www.wealthstrategiescounsel.com

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