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Aug 1, 2019 7:50 AM ET

Tricks Of The Trade: Insuring Residential Rental Property


iCrowd Newswire - Aug 1, 2019

We are often asked how to best own rental real estate. The answer is “not in your personal name, and not in the name of a Revocable Trust or Land Trust that is considered to be owned by you for state law creditor purposes.”

The most common form of ownership of rental properties by well-advised investors is the limited liability company (“LLC”), which can be disregarded for income tax purposes. Ownership under an LLC allows all of the rent income and deductions to go onto the owner’s Form 1040 Schedule E. A downside to this is that not all insurance carriers are keen on insuring property under a company.

Landlord insurance typically covers property damages due to fire, storm, damage, theft, vandalism, and tenant damage. Your insurance policy could also include a provision that provides for compensation for lost income in the event that your rental property becomes uninhabitable due to a storm, fire, or other cause.

The alternatives to giving the ownership to an LLC are described in the following letter that we recently sent to a client who wanted to know which type of ownership was best for them.

Please note that if our client manages the property negligently and something wrong happens at his fault, he still might be held liable.

Please review the following with your insurance agency or carrier to help make sure that you make the right decision with respect to your residential rental real estate, including coordination of umbrella coverage and making sure that there are no prominent exclusions to coverage, so that you will be insured for most of the risks that go along with being a Landlord.

 

If you have multiple residential properties, then you might consider placing them under multiple entities, or possibly having an entity that owns multiple properties owe you money under a promissory note, so that the first monies out would come to you in the event of a liquidation caused by a creditor catastrophe.

Please take a look at the attached letter and email me at [email protected] if you have any questions or suggestions for clarification. Obviously, the law and insurance markets will vary on a state-to-state basis.

(Recent Sterilized Letter to John Smith, Client)

Dear Client:

It was a pleasure speaking with you on Friday.

As we discussed, we typically do not have clients own rental property in their personal name because a lawsuit by an injured tenant or a visitor to the property could cause significant exposure.

This can be offset to a good degree by having proper underlying and umbrella liability insurance that covers rental properties.

Typically you would have $3,000,000 to $5,000,000 of umbrella coverage, and confirm that the umbrella coverage covers most of the things that can cause a landlord to be sued.

There are four methods of ownership that may work for you, depending upon the property and umbrella coverage that the insurance agencies are able to underwrite.

These are as follows, and are discussed below:

 

  1. Ownership by an LLC.
  2. Ownership by a Land Trust that is in turn owned by an LLC.
  3. Ownership by an Irrevocable Trust for family members.
  4. Ownership by Jordan (Your Child).

 

Below is a discussion of each alternative. None of these alternative structures would require the filing of a tax return, in that all income and deduction will be going on the Form 1040 tax return of the deemed owner of each structure.

Ownership by an LLC

Most clients place their rental property into the name of an LLC or an irrevocable trust in order to avoid liability.

Many liability and casualty insurance companies and umbrella carriers will not cover a property owned under an LLC, or will charge more and provide less coverage than when a property is owned individually or under a trust.

I therefore suggest that you share this letter with whoever writes your personal and umbrella liability insurances to see what your options are based upon the present insurance situation, and what might be possible.

Using a Land Trust that is owned by an LLC

Some carriers that would charge more or not cover property under an LLC will provide normal coverage if the LLC owns a land trust that the client is the trustee of, and the land trust owns the property. For income tax and liability insulation purposes, this is generally the same thing as direct ownership by an LLC under Florida law, but also meets personal policy liability insurance company guidelines for some carriers.

Ownership by an Irrevocable Trust

An alternative to using an LLC would be to establish an irrevocable trust. Under the Florida Trust Code, the trustee and beneficiaries of a properly structured irrevocable trust are not responsible for liabilities caused by the ownership or management of a trust asset as long as they were not individually negligent to cause a problem.

An example of an irrevocable trust arrangement would be that you would be the Grantor and Jordan would be the Trustee.

The trust would be for the benefit of Jordan, and can also benefit your other children and Mrs. Smith.

Mrs. Smith could be given the right to receive amounts as she would ever need for health, education and maintenance, and to direct how the trust assets would pass upon her death.

Alternatively, we discussed that the trust could be solely for Jordan, and the Trust Agreement could have language that would define if and when [HE/SHE] would receive benefits, and who the alternate or additional Trustees would be if he were to die.

Many liability and casualty insurance carriers will treat the irrevocable trust like an individual person, although many will not.

Ownership by Jordan

A fourth alternative would be to simply gift the property to Jordan, and also let [HIM/HER] take over the management.

This would take you out of the possible line of fire, and if you like [HE/SHE] could buy the property from you and give you a second mortgage on it.

Your gift could be directly to Jordan, or to [HIM/HER] as Trustee of a revocable trust that [HE/SHE] would have control over, but which would also have successor language in case something were to happen to [HIM/HER].

Please feel free to forward this letter to whoever helps you handle your liability and casualty insurance so they can let you know how this arrangement impacts your present and possible future coverage.

If you use an agency that only writes coverage with one carrier, and the above alternatives do not work, then you may ask that agency to recommend another agency that has access to many different carriers to find a carrier that would be more friendly to one or more of the above recommended structures.

Please note that I recommend that you not be involved or have direct responsibility for tenant, or other aspects of this arrangement to reduce your personal exposure to liability if something goes wrong with the property.

I look forward to receiving a copy of the lease, which hopefully has appropriate language to help protect the landlord and those affiliated with the landlord from potential liability, to the extent that such limitation language would apply under Florida law.

As we also discussed, the transfer of the property to a new entity or Jordan will trigger Florida documentary stamp tax based upon 7/10ths of 1% ($700 for a $100,000 mortgage), and the bank will have the right to call the loan in under the “due on sale clause” that doubtlessly exists in the mortgage, unless you get written consent in advance for this.

I welcome your questions, comments and suggestions on the above.

Best Personal Regards,

Alan S. Gassman

As you can see, determining how to structure ownership in your rental property is highly dependent on facts specific to you. There is not a one-size-fits-all solution to owning rental properties and these four types of ownership are in no way an exhaustive list of what might be available to you.

Similar to the amount of consideration that goes into purchasing a home, a rental property requires careful thought. If you are thinking about owning a rental property we highly encourage you to reach out to an attorney, financial advisor, and an insurance agency before taking action.

Dissimilar to purchasing a home, a rental property purchase is entered into to make money. Ensuring that your ownership of the property is in the most advantageous structure possible is the first step in making sure that your investment is maximized and your risk is minimized.

The last step, and sometimes the most crucial, is making sure that you are covered if and when something goes wrong. Without a proper ownership structure, and without proper liability protection, you could be on the hook for a claim that not only wipes out any profit in the rental property, but causes you to regret your decision to own a rental property for the rest of your life.

Contact Information:

www.forbes.com








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