Asset Protection for Landlords

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Rent it Right

Q: My husband and I are going to rent out my parents’ home, which I have inherited. How can we best protect our personal assets from lawsuits or other claims that might arise during our landlording business? –Fred and Delia J.

A: The best way to avoid trouble is not to invite it. If you learn the rules surrounding the business of being a landlord — and there are many, on the federal, state and local level — your chances of being sued or having to deal with unexpected expenses go down.

Similarly, if you use written contracts with vendors and tradesmen, the chance that you’ll have a dispute concerning the relationship that boils over into litigation will be lessened. Combined with adequate insurance, this offense is your best defense.

But sometimes, despite your best efforts, things go awry. Many landlords in your position want to shield their personal assets from judgments or settlements, and many people automatically think of forming a corporation. True, a corporation will protect your personal assets (as long as you segregate your personal assets from the business assets), but forming and running one is time-consuming and expensive; and you’ll have to file a corporate tax return.

Alternately, you could form a limited liability company (LLC), which will give you the same protection as a corporation, but not require regular board meetings and minutes. You can also pay taxes through your individual tax return, an option not available to regular corporations.

Don’t assume that once you form an LLC for your business, your personal assets will never be at risk, however. Lenders and creditors (vendors) understand that people form LLCs precisely to protect their personal assets — and to limit the creditor’s ability to collect — should the LLC fail to pay a bill or a loan.

And why should the bank or vendor agree to such a limitation? The short answer is that they won’t. Instead, they will probably ask you to personally guarantee loans or the extension of credit to your LLC. This guarantee means your personal assets are at risk despite the LLC structure. In other words, it destroys the limited liability the LLC would otherwise provide.

On the other hand, with an LLC your personal assets will still be protected from claims for personal injuries and violations of the fair housing laws. This protection holds only if you’ve run your LLC as a business entity that’s truly separate from your personal business, however.

If you are sloppy, commingling funds, failing to keep separate books and otherwise disregarding the legal rules concerning LLCs, you may lose the protection you sought.