Why Asset Protection is Needed
Asset protection for real estate investors in Florida is the process where one protects rental and commercial real estate properties from collection by a judgment creditor.
Florida real estate investment can be a rapid path to individual wealth. Successful investing in Florida property has enriched individual investors for several generations. Today, individuals located in Florida and elsewhere hold substantial equity in Florida real property.
The equity owned in the form of Florida real estate makes a individual debtor’s Florida real estate holdings an attractive target for judgment creditors. The best time to plan protection of investment real estate is before taking title to the property. Prior to closing the purchase contract the real estate investor may chooses how he wants own the property. Ownership and titling are the keys to real estate asset protection.
When they start real estate investment, many investors take title to their first properties in their own names, or jointly with their spouse. Individual ownership is the simplest way to own real estate. The individual owner gets directly on their personal tax return the tax benefits of depreciation and other expenses. There are no fees involved in establishing a legal entity or preparing annual entity tax returns. The problem is that there is no asset protection. The individual owner is liable for any claims asserted by a tenant, partner, government agency, or subsequent buyer.
Additionally, the individually owned property is exposed to judgments from financial debts and business activities unrelated to the particular real estate investment.
Ownership of property through a separate legal entity provides a shield against liability from property ownership. A legal dispute involving the investment property will expose only the ownership entity to liability, and the individual owner is protected by the entity’s “corporate shield.”
A money judgment related to property ownership will expose the equity in the real property titled in that particular entity, but the judgment will not jeopardize real property owned by different legal entities nor will the judgment threaten the individual’s personal assets such as his personal financial accounts or operating businesses.
Business Entity Types
There are three business entities that typically are used to own investment real estate: corporations, limited partnerships, and limited liability companies.
All three of these entities provide a “corporate shield” that protects the individual owner and his personal assets from liability related to real estate ownership. However, there are significant differences in the ability of these entities to protect the individual’s ownership interests in a particular property investment from civil judgments from activity unrelated to the real estate property.
In the case where the investor forms a corporation to take title to the investment property, the individual’s investment is evidenced by common stock in the owner corporation.
Corporate stock is vulnerable to judgment creditors. Any judgment creditor can levy on the owner’s stock, take over stock ownership and the corporation, and then proceed to liquidate the corporation’s real estate to pay the judgment. If a judgment debtor has misplaced corporate stock certificates a court can order to issue replacement stock and give replacement certificates to the judgment creditor.
LLCs and limited partnerships provide better asset protection against creditors holding a personal judgment against the individual real estate investor. Investors generally prefer LLCs over limited partnerships because the LLCs are more cost efficient to set up and operate.
A judgment creditor cannot levy upon a debtor’s LLC membership interest, and the creditor cannot obtain lien on the real estate owned by the LLC. Florida law provides that the judgment creditor’s sole and exclusive collection remedy is a charging lien on LLC distributions made to the real estate owner who owns the LLC membership interest. The majority of real estate investments do not produce significant positive cash flow, especially in early years. Without positive real estate cash flow there are small amounts, if any, of LLC cash available to be distributed to the owners.
With a properly drafted asset protection operating agreement, the individual Florida real estate investor acting as LLC manager controls the amount and frequency of cash distributions. If the LLC does not distribute cash flow then the judgment creditor gets nothing from its charging lien. Both the cash flow and real estate remain protected inside the LLC.
The LLC protection described above applies only when there is more than one LLC member. A judgment creditor may levy upon and thereby take over the investor’s membership interest of a single member LLC.
Federal income tax planning for real estate investment is independent of choice of ownership entity. The IRS permits LLCs and corporations to choose how they want to be treated for tax purposes.
The IRS default for LLCs and limited partnerships is tax treatment as a partnership. An LLC can affirmatively elect to be treated as a C corporation or as an S corporation for income tax purposes. Most real estate investors today choose to own Florida real property in multi-member limited liability companies taxed as partnerships or S corporations. The multi-member LLC shields the individual owner from lawsuits pertaining to the investment property, and it provides good protection of the owner’s LLC membership interests from judgments against the owner arising from different real estate liabilities, different business ventures, and unrelated personal liabilities.