Current Trends - Rental Properties & Estate Planning - Episode 43
Hey there, Legal Tea Listeners –This is your host, Jenny Rozelle! Welcome back for another episode of Legal Tea! Today’s topic is a current trend … something going on in current time, that is pertinent to my little estate and elder law world. So, for today’s episode, we’re going to talk about rental properties. Does anyone else feel like everyone and their brother are buying properties to rent out? I have several clients that I hear from them a few times a year, and they’re telling me they bought another rental that they need to add to their overall plan. On top of that, I see posts on social media from my own friends and family … “bought 123 Apple Street and we’re going to flip it and rent it!” That’s why we are talking about it today as a “current trends” episode.
This may be obvious and remedial, but when individuals buy rental properties – those are assets. And what does an estate plan deal with? Assets. So, rental properties and your estate plan are very intertwined. I’m amazed how many times that I meet with clients and when we dive into their assets, they fail to list a rental property – and then, mid-conversation, they mention a rental property and I’m like, “Wait – what rental property?” So, with rental properties, I think there are two major things to discuss within the realm of estate planning – 1) How should you own the rental property? And 2) How does it get incorporated into your estate plan? Let’s tackle them one-by-one.
So, first – how should you own the rental property?
For starters, if you have rentals and they’re in your name, don’t raise your hand – just listen closely. Having rentals in your name individually, as in the property ownership is John and Jane Smith, that opens you up to an immense amount of liability. We live in such a litigious society, and people sue people all the time. So, it’s wise for all of us to protect ourselves, right? The answer is yes – unless you just love to open yourself up to liability!
The issue with rentals are primarily your tenants – if they fall down some uneven front steps, are you liable as the property owner? Or, if you fall short as a landlord according to landlord-tenant laws (meaning you owe the tenant some duties under the law), are you liable as the property owner? Or if there’s a dispute between a provision in the lease, are you liable as the property owner? The handy-dandy thing is that sometimes, rental property owners get adequate insurance coverage. Though, what if the tenant “wins” and the insurance coverage isn’t enough? Are they able to come after you personally? According to a blog by Padula Bennardo Levine, a law firm in Florida, it’s recommended that rental property owners actually place ownership of the rental property in a business entity. I agree. I see this done quite often.
Here, and the blog suggests in Florida too, a very commonly-used business entity, especially for rental properties, is an LLC – otherwise known as a Limited Liability Company. Because the LLC is separate from the individuals, it provides the individuals personal liability protection against those tenants. As the blog suggests, when you use an LLC, you actually move the property ownership into the name of the LLC. Instead of the property ownership reading John and Jane Smith, it reads, whatever-they-name-their-LLC, LLC. If a tenant sues and succeeds in the lawsuit, having the property in an LLC protects the individuals’ personal assets – with the exception of the LLC property (meaning the rental property). That all means – they could “come after” the LLC/rental property, but not the individuals’ OTHER personal assets.
So, if you have rental properties and don’t have an LLC involved, I’m sure you may be thinking, “Okay, okay Jenny – you convinced me. How do I setup an LLC then?!” Well, you have two options – the first option involves setting up the LLC by yourself without professional assistance (like an attorney). You can do that, sure. You’ll need the setup the LLC with your State – in Indiana, we go through the Indiana Secretary of State. Within the Secretary of State, they have, what they call, a Business Services Division. That’s where you go. So, you get that setup, then you need to obtain a tax ID number called an employer identification number. Once that is obtained, you’ll need to create an LLC bank account.
That sounds all fine and dandy, right? Well, they teach out a little thing in law school called “piercing the corporate veil.” Ask any attorney, and they’ve heard of this term of art. What that means is if you make a single mistake in the business CREATION or business MANAGEMENT (after it’s created), the tenants’ attorney may be able to “piece the corporate veil” and attack your personal assets. So, could you setup your own LLC? Sure thing. Just make sure you set the thing up correctly.
Or, say, you’re like, “Okay, Jenny – fiiiiine! I’ll get professional assistance in getting this LLC setup.” Most estate attorneys and even some Accountants can help you get an LLC created – and make sure it’s done correctly. Though, when I, the attorney, is involved in setting one up, I often recommend something called an Operating Agreement, too, which details WHO is in charge of the LLC; WHEN should the LLC members meet; HOW are LLC interests transferred; WHAT happens if a member passes; etc. etc. That’s the document that provides all the nitty-gritty details about the LLC. Without an Agreement, there sure is a lot of gray area.
I hope this last comment (before I shift to incorporating rental properties into your estate plan) does not make your brain explode, rental property owners. To provide the most protection for yourself, it may be wise to have a SEPARATE LLC per rental property. It makes sense when you think about it. If Tenant Bobby sues your ABC LLC which holds ABC Street rental property, Tenant Bobby can ONLY go after ABC Street rental property. Though, if you put ALL your rental properties into ABC LLC, Tenant Bobby can try to attack all the rental properties within ABC LLC.
So, when you have separate LLCs per rental property, you’re essentially separating liability per LLC/per rental property. It sounds crazy and redundant and annoying, but it sure provides the property owner an immense amount of protection. (By the way, yes, this means every LLC has its own bank account; the appropriate tenant should pay the appropriate LLC bank account; etc. Otherwise, if you fail at the management of the LLC, you are at risk of the tenant being able to “pierce the corporate veil.” Which remember, is bad bad bad! That’s when the tenants can possibly attack your personal assets (which is the whole point of having an LLC – to protect those non-LLC, personal assets!).
Alrighty, shifting to the second question here, which is – how does your rental property get incorporated into your estate plan?
As I said earlier, the rental properties are YOUR assets, even though they may or may not be in an LLC, and as such, your rental properties and estate plan should “play nice” with one another. To deal with this question, we need to talk about two points in time – incapacity and/or death. When I say incapacity, I’m talking about cognitive/mental incapacity (due to, say something like, dementia) or physical incapacity (like a coma). The thing to remember for this is you are still living, but can’t manage the LLC “stuff” either temporarily or permanently.
It really depends on whether you have a Living Trust involved – the BENEFITS of having a Trust involved is to 1) avoid the probate court process and 2) perhaps minimize estate taxes, if that is applicable. If there is NOT a Trust involved, you definitely need to have a General Durable (Financial) Power of Attorney, which will grant someone else to manage your legal and financial affairs, if you’re unable to do so. Without a Power of Attorney, a guardianship court process may be necessary to grant SOMEONE authority to deal with legal and financial affairs. So, having a Power of Attorney is, sort of, a bare minimum if you have a rental property and/or LLC involved. Otherwise, if there’s not a Power of Attorney in place and something happens, we may be looking at guardianship, which is costly and is not fast/efficient.
Then, still on the no-Living-Trust train, if you pass away with a LLC and you do not have a Last Will and Testament or all you have is a Last Will and Testament, it’s quite likely that to get someone legal authority to deal with the LLC at your passing is going to require the probate court process. This is because a Power of Attorney TERMINATES at your passing – so that document is no good anymore and the baton shifts to the Executor (or as Indiana calls it, Personal Representative) of your Will or Estate. Without going through the probate court process, no one technically has the legal authority to “deal” with the LLC.
This is why many people that have rental properties and LLCs, especially, have a Living Trust involved so ensure probate is avoided. As the blog by Padula Bennardo Levine mentions, “You can also choose to make a living trust the owner of an LLC that owns rental property, combining the LLC’s asset protection benefits with the trust’s ability to avoid probate, minimize estate taxes, and allow for management of your assets if you become incapacitated.” A Trust offers so many benefits – that it can deal with if you become incapacitated AND upon your passing. It not only deals with both points in time, but it also provides benefits, as the blog suggests, like probate avoidance and in some cases, it helps minimize taxes after you pass.
As we wrap this episode up, if you have a rental property and it’s not in a LLC, or you have a rental property IN an LLC but aren’t sure if it’s setup well, reach out to an estate attorney. And if you don’t have your estate plan setup, get that setup appropriately too. If you’re anything like me, I have so many clients, family, and friends scooping up rental properties – so feel free to pass this episode along to them to make sure they’re protecting themselves … before it’s too late.
Alrighty … let’s wrap up this episode. Next week’s topic is on estate planning of the rich and the famous – on that episode, we’re going to talk about Kurt Cobain – if you’ve lived under a rock and don’t recognize his name, he was the lead vocalist and guitarist in the band, Nirvana. So, for any of you Nirvana fans out there or rock fans, in general, next week’s episode is for you! We’ll talk about ol’ Kurt Cobain next Tuesday, Legal Tea Listeners. Talk to you then and stay well!