Protect Assets From Lawsuit On Rental Property

Q: I have a rental property that I’d like to transfer into a limited liability company (LLC).

However, the mortgage company will not approve the transfer without triggering the “due on sale” clause.

What else can I do as an “asset protection” measure in this case?

A: Many people buy investment property in their own names and later decide that they would like to insulate themselves from potential problems. An investment property owner might like to prevent any litigation from spilling over from one investment property to another or even owner’s personal assets. Separating these assets is important.

One way to achieve some distance and protection from these potential problems is to have the investment properties owned by a corporation or company. This corporation or company would be responsible for the ownership and management of the real estate. If someone were to sue the owner of the real estate, they would be suing the corporation or company.

All states have statutes relating to corporations and most now have statutes relating to limited liability companies (LLC). Both a corporation and an LLC give an owner of the corporation or company protection against third-party lawsuits. A good example of these suits would be if someone were to sue the owner for injuries sustained in an accident on the real estate or a disgruntled tenant suing a landlord.

Your choice of using a corporation or LLC will be dictated by accounting and tax issues. Some accountants prefer corporations and others like LLCs, but either of these choices gives you protection against creditors.

Keep in mind that protection against creditors may not mean that you will be protected against all creditors. When you buy property that is held in a corporation or LLC, your lender will probably require you either co-sign or guaranty the loan that was given to you. In that case, your personal assets are at risk.

But for general issues relating to the property, a person suing the owner of the property should and will sue the corporation or LLC. If the person suing wins, and it’s a big win that can’t be paid by the corporation or LLC, the corporation or LLC would have to file for bankruptcy. Generally, however, the litigation should not involve the shareholders of the corporation or the members of the LLC.

Your lender has decided that they will not consent to your transfer of title from your name into an LLC without triggering the “due on sale” clause in your mortgage. A “due on sale” clause in a mortgage basically states that upon the sale or transfer of interest in the real estate the lender has the option of calling the loan due. If they called the loan, you would have to pay back the loan in full.

Assuming you have a loan you don’t want to refinance, the risk of transferring the title and having the lender call the loan may be too great. In that case, you should make sure that you have sufficient insurance on the investment property. Talk to your insurance agent. You may need to take out additional liability insurance coverage to protect you and your other assets. If you can’t insulate the property by increasing the coverage, then you will have to insulate yourself personally.

Other assets you own (other than the investment property) could be placed in trusts and other asset protection devices. Depending on the complexity of your real estate holdings and other assets you may own, some of these asset protection devices are costly.

If this is your only investment property, the best advice is to manage it professionally, keep it maintained, obtain additional liability insurance and make sure that your current insurance policy has broad coverage and covers the rental use of the property.

Feb. 11, 2005.


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2 Responses to Protect Assets From Lawsuit On Rental Property

  1. HKN says:

    I don’t understand this statement: “One way to achieve some distance and protection from these potential problems is to have the investment properties owned by a corporation or company. This corporation or company would be responsible for the ownership and management of the real estate….” How could the LLC have ownership of the property since the owner can’t refi or transfer the loan to the LLC?

  2. Chad ford says:

    Check into the garn st Germaine act of 1982. Prevents the bank from initiating a due on sale clause when you hold your investment property in a trust. Must be in a trust first before you transfer ownership from self to company.

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