Articles On Asset Protection\Entity

 

Structuring

 

 

 

What Is Asset Protection? What   It Is Not!  Why Asset Protection!!   For My Real Estate, Which Entity Do   I Select – LLC, LP, FLP, Corporation,   Trust?   Best Protection Against Lawsuits –   An LLC? A Trust? Insurance? No, it’s   DEBT! (Part I)   Using Your Own Management   Company   > It Could Cost You!

 

 

What Is Asset Protection? What

 

It Is Not!  Why Asset Protection!!

 

Hello, I’m Albert Aiello and I am a national

speaker specializing in Wealth Protection

where I discuss dynamic strategies covering

tax reduction, IRS audit-proofing, entity

structuring and asset protection targeted for

real estate investors. Following are articles

an overview of a number of topics on asset

protection and entity structuring. Before

beginning, it must be pointed out that I am

not at all encouraging you to use asset

protection to intentionally defraud legitimate

creditors, or cause you to be deliberately

delinquent with your legal and moral

obligations.  Instead, you are to use asset

protecting to protect the equity and income

of you and your family from being attached

by wrongful actions along with sue-happy,

ambulance-chasing, money lust lawyers. 

 

Moreover, while I will frequently use the

term “asset protection” what I really are

teaching is Wealth Protection, because,

while the focus here is asset protection,

there are other important related facets

such as Income Tax Reduction and IRS

Audit Proofing. For instance, an asset

protection vehicle may have a great legal

benefit (such as lawsuit protection); but (like

a drug) bad side effects as to other facets of

wealth protection (such as income tax-

reduction). The frequent result is that the

legal advantage is negated by any such

adverse side effects (and many times

substantially so with resulting financial

devastation). On this CD overview, I will

give you both the legal and in-depth tax

aspects for total Wealth Protection, Asset

Protection.

 

Now as we know, protecting your assets is

of the utmost importance, especially for real

estate investors and especially in today’s

sue-happy society. Unfortunately asset

protection has become an industry, and one

that is heavily marketed and abused with

conflicting and incomplete information being

delivered. It has become overrun with asset

protection mills grinding out thousands of

cookie-cutter expensive kits (such as FLP

kits) that often do not fit the investor’s

needs, or the investor still ends up paying a

lot to a professional to do what the kit does

not cover, or does wrong. And there are

others who sell expensive legal services of

overly complicated  confusing, convoluted

mazes of all kinds of entities and zigzag

charts a rocket scientist could not

comprehend.  Here, my goal to give you an

overview of asset protection strategies that

are very effective, yet not overly

complicated or overly expensive.

________________________________

From Al Aiello’s web site – www.REINFO.com

 

For My Real Estate, Which Entity Do I

 

Select – LLC, LP, FLP, Corporation,

 

Trust?

 

This is a proverbial (and important) question

for the real estate investor. To accomplish

the essential task of selecting the right

entity, first, you have to look at both the

legal and tax side of entities as follows.

 

The three main types of state-registered

entities are

 

(1) Limited Liability Companies (LLC’S), (2)

 

Limited Partnerships (LP’S) and (3)

Corporations (C or S).  

 

Essentially there are two sides to these

entities: (1) The LEGAL side and (2) The

TAX side.

 

The legal side is governed by state statute.

On the legal side, with the proper entity

formalities, these entities all accomplish

essentially the same thing – they give the

entity owners limited liability and thus

protect their personal assets outside of the

entity. So the legal is the legal and does not

vary that much.

 

The tax side is governed by a much wider

more complex body of federal & state tax

law. Accordingly, on the tax side, these

entities could vary greatly as to their tax

consequences with dollar-saving benefits or

costly detriments, depending on which

entity is selected. Many times, much of the

money is made or lost much more on the

tax side of entity structuring than the legal

side. Plus the tax side has subcategories

such as IRS Audit Proofing where certain

entities are audited less than others. Here,

you need to stay updated on which entities

are on the IRS hit list (discussed in other

articles). Armed with this information, if you

use the high-audit-profile entity, you do the

entity structuring correctly along with IRS

audit proofing; or you use another entity if

this other entity is just as effective but a

low-audit profile.

 

You have to look at the total picture and

look at both sides (with generally more

emphasis on the tax side). This two-sided

approach is fundamentally important to

understanding entity selection & structuring.

 

Based on this two-sided approach, here are

some general rules of entity selection for

the real estate investor:

 

1. LLC’s – LLC-Partnerships are ideal for

real estate investments. On the legal side,

you form the LLC for limited liability

protection. On the tax side, you elect the

LLC to be taxed as a partnership giving you

the favorable benefits of partnership tax law

including a low IRS audit profile. This equals

an LLC-Partnership.

 

Note: For more privacy, you could use land

trusts in conjunction with an LLC with the

land trust holding legal title to each

property and the LLC as the beneficial

owner of each land trust.

 

Limited partnerships (LP’s) are another

possible choice for real estate. But, legally,

LP’s are more complex than LLC’s, and on

the tax side are subject to passive loss

limitations whereby the limited partners

cannot currently deduct property losses

against their other ordinary income such as

W-2 income, business income, etc. 

Managing members of an LLC can avoid

such limitations. One of the few times to

consider an LP is in states that tax LLC’s

but not LP’s. However, these states are

very few plus generally the state tax is

based on a net amount. Consequently,

rental property with low net income or tax

losses are often hardly affected. This would

lead us back to the LLC.

 

Family limited partnerships (FLP’s) are LP’s

but with family members. They therefore

have the same drawbacks as LP’s and are

on the IRS hit list.

 

2. Corporations (C or S) – Are for

businesses not involving the ownership of

real estate.

 

Note: Real estate investors should only

use corporations in a secondary role, not

as a primary entity for real estate.  For

example, to take advantage of certain C-

corp fringe benefit deductions, instead of

making the C-corp the primary entity owner

of the real estate, or a management

company; make the C-corp a minority non-

voting partner of a real estate LLC.

 

Rarely (if ever) use S-corporations for real

estate. The “S” stands for small business

and that’s what S-corporations are for

small businesses, not real estate.

 

 

3. Trusts - Estate planning trusts (such as

revocable living trusts*) are used to hold

title to personal property such as your

 ownership shares in an LLC;  for personal-

use property such as your home;  for

paper\financial assets such as stocks. 

Trusts should be used in conjunction with

state-registered entities such as LLC’s; not

in lieu of an LLC.

 

*Note that revocable living trusts do not

give asset protection.  However, there are

other types of estate planning trusts that

also give privacy and asset protection,

such as the Life Estate Trust or

Intentionally Defective Grantor Trust.

These will be discussed in future articles.

 

Consequently, the ideal set up for most real

estate investors is one* LLC-partnership

with each property in a land trust, and the

members’ LLC ownership shares in an

estate planning trust. (*Note: In a later track

I will discuss how you can protect all of your

properties’ equity in just one LLC).

 

In the meantime, choose your entities

carefully and it will save you substantially

from both a legal and especially tax

perspective.

 

Single-Member LLC’s > Beware of Legal &

Tax Pitfalls. Single-member LLC’s for real

estate ownership are what I call one of The

Landmines of Wealth Protection  which are

touted asset protection devices that may

not be all that beneficial. 

 

A Single-Member LLC has little value

because, as opposed to a multi-member

LLC,  it is much more susceptible  to having

its veil pieced and deemed that it legally

does not exist. This would subject the

company’s owner to unlimited personal

liability for debts or torts of the company. 

Claimants in cases against single-member

entities, in efforts to pierce the corporate

veil, often assert that the company is merely

the alter-ego of the owner. While there may

be a degree of asset protection, with the

single-member arrangement, the creditor

will find it considerably easier to

successfully pursue a veil piercing claim. 

 

The other legal drawback is in most states

single-member LLC’s do not get charging

order protection.

 

A charging order is an in-built shield

because it’s what’s needed by a claimant in

order to attach a member’s interest in an

LLC.  First off, a charging order is a judicial

process, which will require the services of a

knowledgeable attorney (probably high

priced). Secondly, even with the charging

order, the judgment creditor does not have

the right to force the sale of the assets of

the LLC because they cannot make

management decisions for the LLC. For the

creditor it could even cause income tax

liabilities (without getting any cash).

Accordingly most charging orders are never

even initiated in the first place. What great

protection!  In most states a charging order

only pertains to a two or more member LLC,

namely an LLC-partnership, not a single

member LLC.

 

On the tax side, single member LLC’s file

Schedule C or Schedule E, which are very

IRS audit-prone schedules.  On the other

hand, a two or member LLC files a

partnership return (form 1065) which is less

audit prone than Schedule C or E. 

 

Consequently, two (or more) member

LLC’s  avoid the legal and tax drawbacks of

single member LLC’s. 

 

If you operate as one person and not as a

partnership, finding other persons or entities

to be additional owners is not difficult.

Another member (or other members) could

be your spouse, other family members or

even better, another entity that you own

such as a corporation, trust and/or another

LLC.  So you can maintain control, these

other partners can have small percentages

of ownership and/or be non-voting members

with no say in management.

 

While the existence of other owners may

not totally defeat a creditor’s claim it

certainly can weaken it, and with LLC

charging order protection it can do so

considerably. Plus there are the excellent

tax advantages of partnerships for real

estate including a lower IRS audit profile.

 

So in summary, for your properties you want

an “LLC-Partnership”.  On the legal side,

you form the LLC for corporate limited

liability protection. You elect the two or

more member LLC to be a partnership

giving you charging order protection along

with the favorable benefits of partnership tax

law.

________________________________

From Al Aiello’s web site – www.REINFO.com

 

What’s The Single Best

 

Protection Against Lawsuits –

 

An LLC?

 

A Trust? Insurance?

 

No, it’s DEBT!

 

(Part I)

_______________________

Albert Aiello, CPA, MS Taxation

 

In this two part article I want to begin by clarifying that

I do not want the title to mislead you in two ways.

First, when I say “debt” I do not mean getting yourself

in hock or using phony liens just to protect your

assets. Instead I will be discussing your own valid

controlled debt which is still your equity but in a

separate entity apart from your real estate; but more

on this later. Secondly, I do not want you thinking that

you should not use an LLC, a trust, and insurance.

This is because there is an important fundamental of

asset protection which I call The Roman Shield

Strategy. The ingenious ancient Romans had a

military formation where their entire army was

covered by numerous shields protecting the soldiers

on every side. It would look like one gigantic shield

defending against the enemy. No one shield, by itself,

would totally protect them; but collectively all of the

shields together were virtually impenetrable, like an

enormous wall. You need to do the same with your

asset protection because no one shield will totally

protect you. You therefore need multiple shields of

colossal protection – an LLC entity, trusts, insurance

as well as other shields including what I believe to be

the most powerful shield of using controlled debt

(Equity Stripping) to deter wrongful actions which is

the central topic of this article. But while these shields

are powerful, they also must be cost effective without

the expense and administrative burden of a lot of

unnecessary entities. This too will be a focal point of

discussion. 

 

It’s no secret that the equity in our investment real

estate is generally our most valuable asset, but also

very prone to legal attacks. This is because real

estate is a physical appreciating asset subject to

many regulations (such as landlord-tenant laws);

exposed to potential hazards (such as environmental)

; and which interacts with many individuals or entities

(such as tenants, buyers, sellers, real estate agents,

contractors, suppliers,  etc.)  All of the above

(regulations, environmental, tenants, buyers, sellers,

contractors, etc.) could very well be the origin of legal

actions.

 

I mentioned three shields of protection – an LLC,  a

trust and insurance. Let’s discuss what these shields

protect, as well as what they do not protect (which is

an important question that you should ask of all asset

protection vehicles).

 

Let’s start with insurance which essentially protects

against slip & fall and personal injury. However,

liability insurance does not protect from

environmental hazards, fair housing violations,

tenants disputes, buyer disputes, seller disputes,

contractor disputes, in fact any disputes which all

could lead to lawsuits. Also, insurance does not cover

judgments that exceed insurance coverage limits from

slip & fall (including intentional self-inflicted injuries),

personal injuries or death.  Such judgments exceeding

insurance limits are becoming more and more common

even if you’re not at fault. And sometimes insurance

companies even try to wiggle out of claims that should be

covered. (The “fine print”)

 

How about trusts? There are many different types. The

one most associated with real estate is a land trust which

gives you important financial privacy by masking

ownership of your properties. However land trusts do not

give you the statutory corporate limited liability of an

LLC.  If the trust is unmasked, and you, personally, are

the beneficiary, your assets are exposed. (In accord with

The Roman Shield Strategy, you should use land trusts

in combination with insurance; and with an LLC which, as

a statutory entity, would then be the beneficiary of the

trust instead of you personally).

 

And how about an LLC?  With the proper formalities, an

LLC gives you corporate limited liability by protecting

your assets outside of the entity, such as your home,

second home, stocks, personal savings, expensive

jewelry, art collection and other personal valuables.

However, while it  protects your personal assets outside

the entity, an LLC does not protect the property equities

within the entity.  Such equity essentially comes from

appreciation, upgrading and mortgage amortization. So

before you know it, you can have significant equity that

you need to preserve. Also remember that with multiple

properties, we are talking about each property’s equity

that we need to protect from not just a legal action on that

property, but from a legal action of another property in the

same LLC. 

 

An example of unprotected equity (and a target for

claimants) is six properties below in a real estate LLC.

 

Total Value	$1,000,000  (6 properties)
- Mortgage loan	-  400,000  (first mortgage; bank’s equity)
= Your RE equity	$  600,000  (target for claimants)

 

Now in reviewing the above, the bank loan of $400,000,

is that a target for claimants? NO! Because who wants to

sue for debt. Lawyers want blood, not stone; they want

deep pockets, not empty ones.

However, the bank loan of $400,000 is equity, not your

equity, but the bank’s equity in a separate company not

reachable by a potential claimant of you. So, why not do

the same with your $600,000 equity – make that debt

which would be equity in a separate company not

reachable by a potential claimant of you.  Only here the

bank, with the $600,000 of equity, is your separately

owned lender LLC which is a non-risk entity because it

only would own the mortgage, a paper asset that is

not the cause of legal actions. 

 

This is known as Equity Stripping .

 

The end result is that the real estate LLC will have

publicly recorded debt completely stripping out the

property equity, along with avoiding a lawsuit target

and avoiding the courtroom. In the above example

this debt would be the bank’s first mortgage of

$400,000; your lender LLC’s second blanket

mortgage of $600,000 (plus accrued interest every

year) or a total of $1,000,000+ recorded debt against

the $1,000,000 value, with  NO or even negative

equity as seen in the public records. Believe me, this

will ward off claimants along with their money-hungry

lawyers, the way a cat scares off rats (no pun

intended).

 

In part II of this article (next issue) I discuss how

equity stripping works and its overwhelming

advantages.

__________________________________________

From Al Aiello’s web site – www.REINFO.com

 

Using Your Own Management

 

Company > It Could Cost You!

 

Investors are often advised to use another

separate corporate entity to manage the

properties. The legal reason for this is that

the separate entity will act as your rental

property management company as a decoy

in dealing with tenants, contractors,

vendors, etc.  In the event of a legal dispute

or action from one of these (tenants,

contractors, vendors, etc.), the

management company (acting as a decoy)

is a separate and distinct entity apart from

you.  Presumably, any legal action will be

brought against this managing corporation

and not against you, or not against

whatever entity owns the property (such as

an LLC).  This management corporation will

have little assets to attach in the event of

the legal action. This is why it may give you

additional asset protection.  But, on the

legal side, for this asset protection strategy

to work effectively, the management

corporation must do all of the managing.  If

you, in your capacity as an individual or as

a real estate LLC member, do any

management at all, then claimants could

bring a legal action against you or your real

estate LLC, instead of the management

corporation. A smart attorney may be able

to prove that you or your real estate LLC did

at least some management (or were

somehow responsible) and therefore liable

to the claimant (tenant, contractor, vendor,

etc.) and thus not even bother suing the

decoy (limited asset) management

corporation.  So, legally, this asset

protection device could be flawed and is

potentially collapsible.

 

On the tax side, there too is a potential

significant pitiful. One of the most expensive

tax traps for the uninformed real estate

investor is the passive loss limitations

depriving investors the ability to currently

deduct their property loss deductions

against their other ordinary income (W-2,

 business income, etc.), with the resultant

loss of tax savings and decrease in after-tax

cash flow. If this separate rental

management entity does too much

management (when legally it’s suppose to

do all managing), then you may be too

passive and thus may not be able to

currently deduct rental property losses

because of the passive loss limitations of

IRC 469. Reason: In order to bypass these

limits and deduct losses you or your spouse

must perform a certain amount of

management functions, especially landlord-

tenant activities. These functions must be

performed by you or your spouse

(individually or as a manager-member of an

LLC that owns the properties), not another

entity, even if it’s your entity.  Understand

that the management company (corporation

or another LLC) is a separate, distinct entity

apart from you and your spouse. Thus the

management company’s performance of

these activities is not attributable to you.

Because of this, there are several tax courts

cases where real estate owners, using

separate management entities, were denied

current property deductions costing them

thousands of dollars in current savings.

Moreover, top tax experts throughout the

country agree with these conclusions of the

courts based on IRC 469.

 

You do not need your own management

corporation, along with its legal and tax

disadvantages because there is an

excellent cost-effective solution where you

can protect multiple property equities in one

entity called Equity Stripping which is

discussed in the prior track. 

 

From Al Aiello’s web site – www.REINFO.com

 

Don’t miss Al’s dynamic presentations.

Learn how to save thousands of dollars by

protecting all of your assets!

 

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