Whatever You Do, Don’t Put It in Your Own Name!
If you don’t get anything else out of this article, get this—It is unwise to hold title to your rental properties in your own name. Why? Because when you hold title to your investment real estate in your personal name, you personally take on any liability that accrues to that property.
For example, you hold title to a building in your name. The ceiling caves in due to a roof leak and injures the tenant. Your tenant sues, wins, and your property insurance (please tell me that you do carry insurance on all your rentals) will only pay off part of the tenant’s winning claim, which means you are personally liable for any balance of the award that remains unpaid. So, in addition to any equity you may have in your building, the tenant can go after the value of your personal residence, your cars, your watch, vacation property you may own, your boat—any of your unprotected personal assets, in order to pay off the winning judgment against you.
If Not in Your Own Name, Then How Might You Hold Title to Your Rentals?
In order to facilitate the smooth flow of commerce and encourage the taking of entrepreneurial and investment risk that ostensibly increases society’s overall wealth and well-being, over centuries the legal system has developed and recognized doctrines that for purposes of this article we’ll call, “entity structuring,” which allows investors and entrepreneurs to invest in assets and businesses while limiting their personal liability exposure with respect to those assets and businesses.
What Exactly Is an “Entity” and “Entity Structuring” for Real Estate?
An entity for entity structuring purposes is a legal construct (simplistically, legal paperwork that is drafted, filed, and recognized by the legal system) that creates a “fictitious person,” if you will—a person that, in the eyes of the law, sits apart from the actual, natural, person(s) setting up the entity—that holds title to, and operates the property on behalf of the underlying natural persons that formed and currently owns the entity.
And why would you want to create a “fictitious person” (from now on we’ll call this an “entity”) to hold title to your real estate, or other assets, instead of simply placing title in your own name? Because if the entity owns the property, then the entity is the one that any liability accrues to should there be a legal judgment against the property—so long as the entity is properly set up and all rules have been followed, the liability does not accrue to you personally.
People set up entities for various reasons, including tax planning, succession planning (i.e., what happens to the property after the natural owner(s) dies) and, perhaps most prominently, to act as a liability shield for the underlying natural owners of the entity. Confusing? Perhaps two contrasting examples will clarify:
Example 1 – No Entity Structuring
Joe buys a building and opens a restaurant in that building—everything is owned and operated in his own name. Somehow, purely accidentally and with no malice on anyone’s part, a foreign object finds its way into a meal, a customer eats the meal and gets violently ill. The customer sues, wins, and is awarded a judgment of $20,000,000 against the business. Joe’s business and building combined are worth $10,000,000. Because of the winning judgment, the customer now takes title to both Joe’s business and building—they now belong to the customer.
But wait! There’s more! Because Joe ran the business in his own name, and because he also placed title to the building in his own name, not only does he lose the business and the building, but the customer can also go after everything else that Joe owns, up to the remaining balance owed of $10,000,000. Why? Because, since everything was in Joe’s name, the judgment was against Joe personally. Poor Joe.
Example 2 – With Entity Structuring
Joe is a savvy businessman and investor who is fully aware of the benefits of entity structuring. He buys a property and through his attorney creates an entity called “ABC Property Holdings” to take title to the building—Joe is the sole owner of the entity (NOTE: Joe does NOT own the building—the entity owns the building. All Joe owns is the entity).
Next, through his attorney, Joe creates an entity called “XYZ Restaurant Holdings” to both own and operate the restaurant, and files for a fictitious name called a “DBA” (Doing Business As) of “Joe’s Chili & Ribs” for marketing purposes. Joe is the sole owner of this entity (NOTE: Joe does NOT own the restaurant company — the entity owns the restaurant. All Joe owns is the entity).
Next, through his attorney, Joe arranges for “XYZ Restaurant Holdings” to sign a lease with “ABC Property Holdings” for the purpose of operating a restaurant on the premises. Joe opens his restaurant in the leased building. A foreign object finds its way into a meal; a customer eats the meal and gets violently ill. The customer sues, wins, and is awarded $20,000,000. The business is valued at $3,000,000, and the building is valued at $7,000,000 (the same combined valuation as in the first example). So what happens?
Remember, Joe did not own either the business, or the building, just their respective entities—all Joe can lose is any value within those entities, but so long as the entities were set up properly and all of the rules followed, the judgment cannot reach beyond the entities to Joe’s personal assets.
The restaurant prepared the meal, and the judgment was against the restaurant. The value of the restaurant was $3,000,000, which is awarded to the customer. Since the restaurant does not have any assets beyond the $3,000,000 valuation, that is the limit of the award that the customer can collect from the entity—there is nothing else available to collect. As the owner of the entity owning the restaurant, Joe loses his entire $3,000,000 interest in the restaurant. So far as the assets of the restaurant are concerned, Joe loses everything, but none of his assets outside of “XYZ Restaurant Holdings” can be touched.
As for the building and its $7,000,000 valuation, it is shielded from the judgment because it did not own or operate the restaurant—it was merely the landlord. Notice that shrewd entity structuring shielded $17,000,000 of Joe’s assets from the judgment.
While this is a rather elaborate example for purposes of illustrating the point, the same principles apply to a rental house, or condo you might own. If you hold title to the rental in your own name and the tenant wins a judgment, because the roof caved in and injured them, they can not only go after the rental to satisfy the judgment award, but also any other assets held in your name. Holding title to the rental in the name of a properly formed and administered entity limits the reach of the judgment to the value of that rental and nothing more.
Always Talk to Your Attorney About Which Entities May Be Right for You
I am of the opinion that you should never take title to real estate in your own name—you should always take title in the name of a properly formed entity. There are several types of entities to be considered, each with their own pros and cons given your individual situation and desired outcome, so I am not going to recommend any particular entity for you. What I will recommend is that you seek out expert guidance and advice from your own personal attorney and tax professional before attempting to operate using entities to hold title to your properties.
Should you find yourself currently holding title to real estate in your own name, all is not lost. Talk to your attorney about setting up an entity appropriate for your individual needs, and have the title to your property transferred into that entity’s name. Such transfers are relatively easy to do, and not doing so exposes you to potentially catastrophic financial loss should there be a judgment against you and your property. Make sense?
About the Author
John Michailidis, JD, is a graduate of the Northwestern University School of Law in Chicago and is the Broker/Managing-Member of Real Property Management of Sarasota & Manatee, a Sarasota, FL based residential property management company. Real Property Management of Sarasota & Manatee provides both Full-Service and Lease-Only services to greater Sarasota, Bradenton, Venice, and North Port area landlords. If you own residential investment real estate anywhere in Manatee or Sarasota counties, do feel free to reach out to our team at 941-216-0005, or through our website.
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