With any investment, risk is inherent. But that is not to say that all risk is unavoidable. In fact, there is such a thing as unnecessary risk. And all too many rental property owners tend to overlook this fact.
Unnecessary risk in the world of property rental can take on a number of different forms. Perhaps the most common (and most dangerous) of these unnecessary risks relates to ownership and titling of the property.
Let’s start with an example: John and Jane are married and own their personal residence, valued at $150,000, and a rental house across town, also valued at $150,000. Both the house and the rental property are titled in their names. The rental property is leased to Bob, his wife and one minor child. One afternoon, Bob’s child is playing on the back deck. Unbeknownst to John and Jane, the railing on the deck has loosened due to age and water damage. As Bob’s child leans against the railing, it comes loose and the child falls off the deck, sustaining significant physical harm. If Bob decides to sue someone for the damages related to his child’s injuries, to whom will he look? Very likely, he will demand compensation from the owners of the property, John and Jane. If they are determined to be liable, John and Jane (personally) will be responsible for payment of these expenses.
In this example, depending on the child’s injuries (and damages for pain and suffering), John and Jane could potentially face judgment liens against their rental house, their personal residence and any other asset they currently own. In short, John and Jane’s personal assets (home, bank accounts, cars, boats, etc.) are exposed and at risk of being lost if something unexpected happens.
The good news is that risk presented in this scenario (and others like it) can be greatly reduced. Let’s take the same scenario but change one fact: John and Jane form a limited liability company (an “LLC”) to own the rental property. In this case, if Bob wants to sue the owner of the property, he would have to sue the LLC. The advantage here to John and Jane is that their LLC is only liable to the extent of the LLC’s assets. Here, the only asset owned by the LLC is the rental house. That being the case, if Bob’s child has $250,000 in medical bills, he could only recover $150,000 (the value of the rental house) from the LLC, leaving John and Jane’s personal residence and other assets protected.
This simple step (along with others, such as obtaining insurance coverage and using a well-drafted rental agreement) can reduce a landlord’s risk in investing in long-term or nightly/vacation rentals. By owning and operating a rental property without taking certain protective measures, a landlord exposes himself or herself to a world of unnecessary risk, particularly considering that the cost of forming and maintaining an LLC is relatively inconsequential.
Forming an LLC is a great first step that can be taken to protect landlords and their personal assets from exposure to unnecessary risk. If you want to make your investment into rental property much safer, there’s no reason not to do it as safely as possible.
Contact us today to learn more about protecting yourself or to find out how we can help.