Does transferring my investment property to an LLC really protect me?
Clients with real estate ask me this question on an almost weekly basis because there is so much confusion about how limited liability companies work with respect to an owner’s liability, especially in the context of dealing with tenants.
If you’re afraid of a tenant suing you personally, the answer really depends on the circumstances that gave rise to a lawsuit.
But let me backup a bit to give you some more context.
How does a Massachusetts LLC protect me?
In Massachusetts, the limited liability company act states that an LLC may, and shall have the power to, indemnify and hold harmless any member or manager or other person from and against any and all claims and demands whatsoever.
Furthermore, “(b) To the extent that, at law or in equity, a member or manager has duties, including fiduciary duties, and liabilities relating thereto to a limited liability company or to another member or manager, (1) any such member or manager acting under the operating agreement shall not be liable to the limited liability company or to any such other member or manager for the member's or manager's good faith reliance on the provision of the operating agreement, and (2) the member's or manager's duties and liabilities may be expanded or restricted by provisions in the operating agreement.” (my emphasis)
Put differently, if you are an owner of an LLC (also known as a “member”) then, unless your operating agreement states otherwise, you generally are not personally liable for the acts of another person (whether that be a manager or another member / partner of the LLC) that gives rise to a lawsuit.
Therefore, if a tenant decides to sue for something like a slip and fall, they generally would have no recourse against the members, personally, of the LLC, but may only be able to sue the LLC itself since it is the LLC that is listed as the owner of the property.
By having each of one your investment properties in separate LLCs, you are thereby able to insulate them from one another. In other words, if Building A is owned by LLC A and Building B is owned by LLC B, and if a tenant fell at Building A, then that tenant could only sue LLC A and would not be able to implicate Building B (which is owned by a different company, LLC B).
Put another way, if a tenant wants to sue the owner of a building and the building is owned by an LLC, all your assets outside that LLC are generally protected. So if the tenant decides to sue only the property owner (the LLC), then you’re good with respect to shielding personal liability.
But what if the tenant decides to sue the property owner and the property manager for negligence?
This is where things can get tricky.
If you are managing the property yourself, there is nothing stopping the tenant from suing you individually for actions you’ve personally taken or failed to take with respect to the safety of the building.
Therefore, even if the LLC shields you by having a separate entity listed as the property owner, it doesn’t necessarily protect you as the property manager. So, if you own a small rental property and cannot afford to hire an independent property manager, then you are once again at the mercy of the tenant.
What if I create another entity / LLC to be listed as the property manager?
It’s possible that by adding layers of entities between you and the tenant, you could cause sufficient confusion to ward off a small claim. But for major claims, any competent personal injury attorney will be able to see through the smoke to sue the individual allegedly responsible for causing harm to the tenant.
So what can I do to protect myself personally if I am currently managing my rental properties myself?
Consider hiring insured property manager. Ideally, you should hire an independent professional property management company that is fully insured and make sure your contract states that the property management company is responsible for any and all property management claims.
Consider current insurance coverage. If you cannot hire a property manager, make sure you have adequate insurance on your end personally (whether through an umbrella policy or other insurance that specifically covers your concerns.)
Hire licensed/insured contractors for all work and maintenance on building. Hire independent and insured contractors whenever feasible to create as much legal distance as you can from yourself and the building. Make sure all contracts state that the independent contractor is responsible for any potential claims arising from their work.
What if I place my rental property in a nominee realty trust and have the LLC as the beneficiary of that trust?
Nominee realty trusts do not protect you from personal liability, but are often used as a privacy tool since there is no way for a tenant to be able to tell, based on public records, who actually owns the property. The only thing they would be able to see publicly by searching the registry is who is acting as agent or trustee on behalf of the realty trust. Therefore, if you have someone other than yourself (and ideally, someone with a completely different last name than you) acting as the trustee of the realty trust, then the tenant may give up pursuing a small claims lawsuit since figuring out who the actual property owner is will likely require hiring an attorney and going through a discovery process.
In other words, nominee realty trusts may be a deterrent at best, but are still not guaranteed to protect you personally from lawsuits. By having the LLC as the sole beneficiary of the nominee realty trust, you create a layer of protection against claims related to the building and not arising out of actions done (or failed to be done) by you personally - which would be helpful if the tenant does have a major claim and hires an attorney to discover the underlying beneficiary of the nominee realty trust.
Need help with your estate planning?
If you would like to review or update your estate plan, then give me a call at 781 202 6368, email jlento@perennialtrust.com, or click here to schedule your free personal consultation.
I’m always happy to help!
Joseph M. Lento, J.D.
Your Local Estate Planning Attorney
www.PerennialEstatePlanning.com
477 Main Street
Stoneham, MA 02180
Other articles you may find helpful:
The 5 Goals of Estate Planning
How Do I Avoid the Massachusetts Estate Tax? (4 Proven Strategies)
