Just like investing in stocks, bonds, or early stage companies, there are many risks to owning rental properties. The risks are of a different nature though and one of the risks that can be catastrophic is the risk of litigation that affects your personal property. If you keep rental properties in your name, you run the risk of someone having a major accident on the property and suing you personally for damages. That means their lawyer would look at all of your assets (rental house, main house, savings accounts, etc.).
There are two mechanisms you can use to protect your personal assets:
- Move the property to a LLC via a quit claim deed – this would mean that a lawyer who was going to sue you could only look at the LLC (which owns the property) and could only sue for the items that the LLC owns (the LLC’s rental house and the LLC’s bank account). They will look closely to see if any funds were co-mingled which would essentially let them say you were managing the LLC as your personal account and therefore they could sue for your personal resources as well. The bank may also have a problem with the quit claim process (the due on sale clause); although, I have never heard of this happening. You would need to make sure that the ownership of the LLC is the same as the current ownership of the property (so if you and your wife own the property 50/50 today, you should be equal members of the LLC).
- Get an umbrella insurance policy – this can either be done with the property in your name or as an added measure of protection after the LLC process. With the umbrella policy, the lawyer would look to sue either you or the LLC and if they determined in some way that you were personally liable, your umbrella policy would kick in and attempt to settle with the lawyer. The goal of the umbrella policy is to ensure it is large enough that the lawyer would rather settle than sue you. So if you had $1m in liquid assets you should have a $1m umbrella policy, if you had $2m in liquid assets you should have a $2m policy, and so on. The goal really being that the insurance policy could reasonably settle for more money or in a shorter timeframe than the lawyer could reasonably get from continuing to sue.
I get asked a lot about how I use these strategies and for my rental properties, I use both strategies. This is mostly because I have multiple rental properties and would hate to have one rental property affect another or any of them to affect my personal home, cars, kids college funds, etc.