Saturday, April 30, 2011

Preventing Assets From Becoming Liabilities

In addition to ensuring that your hard-earned assets are passed to your loved ones in an efficient manner, comprehensive Estate Planning also involves exploring ways to protect and preserve those assets.  After all, if you are wiped out by a lawsuit, you could have the most beautiful Estate Plan in the world but it won't provide for your children or other beneficiaries because there won't be anything left to inherit.  One of the most common types of asset to protect is investment real properties.

Whenever I see that a client owns investment or rental real properties, I always have a discussion about liability protection and whether forming one more Limited Liability Companies ("LLC's") to hold the investment properties would be appropriate.  An owner of investment real properties can be liable for millions of dollars if there is an injury or a death on the real property.  Creditors who have a legal claim against the owner of real property arising out of the property are known as "inside creditors."  An properly formed LLC can limit the property owner's liability to those assets that are held in the LLC, preventing the inside creditor from going after personal assets or other investment assets that are not held in the LLC.  When clients own multiple investment properties, sometimes it makes sense to form multiple LLC's to further minimize risk.

Investment properties are also at risk if the property owners are sued for personal reasons such as a car accident, professional malpractice, or a business deal gone wrong.  Creditors who have a legal claim arising out of such alleged personal transgressions are known as "outside creditors."  Generally outside creditors are able to attack investment real properties, even if they are held in an LLC.  However, certain states such as Wyoming and Nevada provide protection of LLC assets from outside creditors as well as from inside creditors.  Such states prevent outside creditors from seizing properties held in an LLC and instead only give the outside creditors a "charging order," a right to any distributions made from the LLC to the LLC member.  The LLC would simply refrain from making any distributions to the LLC member and the outside creditor would be empty-handed.

Because of this additional protection against outside creditors, it often makes sense to form an LLC under the laws of favorable states such as Wyoming or Nevada, even if all of the properties or businesses held in the LLC are located in California.  It's not certain how a California court would apply the law, but it still provides a degree of creditor protection against outside creditors that California LLC's do not provide.

Protecting your assets is often as important as planning your Estate in the first place.  While asset protection is not appropriate for everyone, it's an issued that should always be considered.