Real Estate Asset Protection Strategies Can Protect You in Other Areas.
He must have been sweating bullets when he got the news.
John, a successful business man and owner of several car dealerships, got the call that his 16-year-old son had just rear-ended my car. Naturally, John’s first concern was the safety of his son. After learning that his son was healthy and unharmed, his next thought doubtlessly went to the real risk that I would sue him and place his business, his assets and his family’s financial security at risk.
I’m not going to do that. John’s son made an honest mistake, and everything is being taken care of. Sadly, filing a lawsuit resulting from a simple fender-bender would be entirely consistent with the “victim mentality” adopted by a large swath of the American public who will seize upon any opportunity, no matter how frivolous, to use the legal system to take away the assets of anyone they feel to be a suitable target.
As a real estate investor, you’re a prime target for such financial terrorism. Along with mundane risks like fender benders, you also face the risk of legal action from tenants, contractors, and anyone else who happens to set foot on your property.
That’s why asset protection has taken center stage as a concern for serious real estate investors.
What is Asset Protection?
“Asset protection” refers to a collection of laws, strategies and practices that make it harder for anyone to take away the things you own. Whether your home, your financial accounts, your retirement savings, your business or any other type of asset, a good asset protection plan can serve as a major stumbling block to financial vampires who would prefer to take what’s yours rather than earn their own.
Attorneys who provide guidance on asset protection are experts in a branch of law called debtor/creditor law. This type of law gives guidance on the circumstances under which a person who holds an obligation (a creditor) can take away the assets of a person who is subject to an obligation (a debtor).
Asset protection strategies can range from very simple to incredibly complex, but the core principle is this: The creditor can’t take what the debtor doesn’t own. Thus, the central strategy of asset protection is to structure your affairs in such a way that you get the benefits of owning your assets without actually being the legal owner.
But before we protect your assets, you need to understand how you could possibly lose them…
How Your Assets Could Be Taken
Imagine it’s you instead of John who has a child or spouse in a traffic accident while driving your car. Your family member is judged to be highly negligent, and the severity of the accident leads to a huge lawsuit against the family member and, by extension, against you. Unfortunately, you lose that lawsuit and are obligated to pay the other party $5 million.
Interestingly, the simple act of losing a $5 million lawsuit does not mean that you have yet lost any assets outside of the legal expenses of fighting the lawsuit. If the winner of the lawsuit wants to get any benefit out of the judgment, they will have to use debtor/creditor law to exert the authority necessary to take your assets.
As a result, they might file the paperwork necessary to drain your bank account of cash, place a lien against your home or take ownership of your vehicles, or even attempt to drain your retirement savings. By and large, anything you own is at risk in such a situation.
Some of your assets may face greater risk of confiscation than others. For example, the law makes it more difficult for a creditor to drain your retirement savings than to drain a checking account. But most assets are not subject to such favored treatment, and no assets have absolute protection.
Ultimately, the risk that any particular asset of yours is confiscated by a creditor is determined by two things:
- The “structure” of your ownership of that asset
- The debtor/creditor law that governs your circumstances.
That, then, is the goal of asset protection: To anticipate the legal risks one might face in advance – even if by accident rather than negligence – and to minimize or eliminate those risks, even if you are subject to a legal judgment.
The Basic Tools of Asset Protection
The most common tools used by asset protection attorneys are legal entities such as corporations, partnerships and limited liability companies (LLC). Each of these types of entities have different purposes, tax rules and debtor/creditor rules, but one thing that is common to them all is this: Used properly, these entities are viewed as separate legal “persons” under the law.
Separate legal “personhood” is very important for asset protection. This makes it possible for you and any entities you own to have separate liability, such that a huge legal problem for either of you doesn’t automatically mean that both of you have that legal problem.
For example: You own shares of XYZ Incorporated which, unfortunately, is faced with a huge lawsuit. Since you own a portion of XYZ, are you obligated to hire attorneys and help to fight that lawsuit? No, you are not, because XYZ is viewed in the law as a distinct legal “person” with its own legal liabilities that are distinct from the liabilities of its owners.
But consider the opposite problem: You own shares of XYZ Incorporated, but this time it is you (not XYZ) who loses a lawsuit. Since the judgment entitles your opponent to take your assets to satisfy that judgment, then it is entirely possible that your shares of XYZ stock (along with any of your other assets) could end up as the property of your opponent.
The protection provided by legal entities is strong, but not absolute. They have a definite role in a strong asset protection plan, but as you can see, the protection they provide is unidirectional. You’re usually protected from the obligations of any entities that you own, but your ownership of those entities is still entirely at risk in the event you face personal legal obligations.
The question becomes: How could you have faced the same situation – including the loss of the lawsuit – without the risk of losing your assets?
The Most Powerful Asset Protection Tool of Them All…
Owning an asset means that asset can be taken from you. The ideal scenario is not to own assets, but merely to benefit from them.
That capability is precisely what is offered by the most powerful of all asset protection tools, the “Trust.”
Unlike corporations, partnerships and LLC’s, trusts are not a legal entity or a separate legal person. A trust is not a business. A trust is simply an agreement whereby one party owns an asset in their own name, but they agree to pass the benefits of those assets on to someone else.
A common but informal example is the grandparent who has set aside a sum of money to be used for the education and personal needs of a grandchild who is entering college. The grandparent could directly gift the money to the grandchild, but rather than doing that – and risking the inappropriate spending of the money by the grandchild – the grandparent chooses instead to maintain control of the money and distribute it as suitable needs arise.
Inadvertently, the grandparent has given another wonderful benefit to the grandchild: Legal safety. If the grandchild, who is now legally an adult, finds himself in a car wreck or in other legal jeopardy, any assets owned by the grandchild would be at risk. But because the grandchild’s money is still legally owned by the grandparents, any legal problems faced by the grandchild will not extend to the money being held for him by his grandparents…
…And that is the essence of a trust. In that case, the grandparents serve as the “trustee” because they are in control of the money. The grandchild serves as “beneficiary,” because the money is being used for his benefit.
How Trusts and Entities Work Together for Your Safety
If you have assets to protect, the combination of a trust and one or more legal entities may be a great way to provide a very high degree of confidence for you in the event of legal problems. A common basic strategy works like this:
First, hire an attorney and establish a well-drafted trust. You’ll want to work with an attorney who has specific and substantial experience in trust law.
Second, with the guidance of your attorney, you “contribute” your assets to your trust. This has the effect of removing legal ownership of your assets from you and placing that ownership with the trust.
Third, if you want to run a business or make investments, set up the appropriate business entity so that it is owned by the trust rather than by you, and operate entirely through that entity rather than through any entity you directly own.
By transferring your assets into a trust and by using a business entity to contain your investments or business activities, your assets are protected from each other and from any legal liability you might face.
How to Get Started
Asset protection is truly important for real estate investors. Furthermore, asset protection comes with a unique and compelling caveat: If you wait until after you’re facing legal problems to set up an asset protection plan, you’ll soon find that your plan is disregarded by the courts.
That’s why it’s important to study, understand and implement a good asset protection plan – under the guidance of an experienced attorney – right now. When you do so, your assets will be protected, and you’ll be able to rest easy, knowing there’s a legal fortress supporting your family’s financial security.
Bryan Ellis is the CEO of Self-Directed Investor Society and one of America’s leading independent experts on self-directed retirement accounts.