I talk to many clients that think buying an Umbrella Insurance policy is a “no brainer”. I don’t know if I completely agree with that belief and think it’s important business owners understand what they are paying for and actually getting.
Yes…its very affordable, and so for many they think “the annual premiums are so cheap and if it gives me any additional protection or peace of mind- why not?” However, lets talk about that ‘additional protection’ you think you are getting.
Excess not ‘Gap’ coverage
Many people think that umbrella insurance is great coverage because it will ‘fill in the gaps’ and cover me if my regular auto, home owners or rental insurance doesn’t cover me- WRONG. Umbrella insurance is built to be there for ‘excess’ claims that might exceed your regularly insurance policy. Moreover, the umbrella policies oftentimes have very specific provisions that it won’t pay out any benefits until primary policy in place has been exhausted.
Example. You have insurance on one of your rental properties and mold is discovered. Regrettably, our owner policy doesn’t cover the claim, so you think you can rely on your umbrella policy to come to your rescue- Don’t count on it! The umbrella policy doesn’t cover the gaps in your standard policy, only the claims that might exceed it.
Another way of saying it is that your umbrella policy works in ‘concert’ with your other liability coverages (say even an uninsured motorist blindsides you)…your primary insurance may cover the injuries caused by this driver up to a point, but then the umbrella policy takes over when your other liability limits have been reached and covers any excess claims.
What are we actually trying to protect?
Many think an LLC or Corporation is all we need to protect ourselves or our assets from our business operations or rentals. However, that’s not what I’m talking about here. Yes we need to have entities and good asset protection to protect us from our business ventures or the tenants in our rentals, however think about liabilities that don’t involve your business.
Look from a different perspective for a moment. Think of a lawsuit or cause of action that could take away your business. This is liability that isn’t created by your business, but by your personal actions! I call this type of liability “Outside Liability”– Exposure created outside our business that could allow a creditor to take our business or rental property away from us.
Many consider this a unique approach to asset protection because they have never heard it explained in this manner. However, I want you to know this exactly is how courts and judges view asset protection when a creditor is going after assets, and many misunderstand the true methods to protect their assets.
Let me share an example that may bring this home. Recently, I had a client get in a car accident that was clearly his fault (texting and driving). Another driver and passengers were seriously injured and the claims are going to be in the hundreds of thousands, if not over a million.
What makes the situation more precarious is that my client owns a successful business, a few rental properties and a personal home (with equity in it- believe it or not).
To be honest, the case is far from settled, but we are carefully re-assessing his asset protection plan. Regrettably, he and his wife had not taken asset protection that seriously in the past because “they didn’t think it would happen to them”. This is exactly the time an Umbrella Policy would be of great help to my clients. Hopefully, his auto insurance will cover the initial claim, but it’s a good chance the claims could exceed policy limits. That’s when the umbrella insurance could kick in and cover the excess claims. We’ll see what happens in this case and situation, but the jury is still out (no pun intended).
Here is another look at the power of Umbrella Insurance with a video I produced on YouTube:
The truth is that umbrella insurance can be one of the most affordable forms of asset protection and should be one of your front line defenses. However, I want to ask of you to really drill down and interview your insurance agent to make sure you understand the boundaries of YOUR policy and what it actually covers.
Again, it’s such an affordable option to complement a good asset protection plan at a cost on average of $300-$500 a year for $1M to $2M of coverage, so don’t ignore it. Without umbrella insurance, you could be obligated to pay out of pocket for legal fees, medical bills, and damage expenses that exceed the limits of your underlying primary policies.
Bottom line, have an annual review with your attorney regarding all of your asset protection techniques and exposure and implement the most affordable plan expanding it as your assets grow.
This is a very important area of employment law, and far too many business owners cut corners in this area and don’t think it’s a big deal- IT IS a big deal. How you classify a ‘worker’ in your business, whether as an employee or sub-contractor, can have far reaching effects to you AND your business.
I understand the business owner’s plight. Many entrepreneurs are wary of the costs and extra paperwork to bring on an ‘employee’ in the business. Terms such as SUTA, FUTA, FICA and Workers Compensation will often times deter the employer into making the ‘right’ decision, and it could ultimately be devastating to their business.
Bottom line, some business’s try and treat their “employees” as “sub-contractors” and 1099 them rather than set up payroll and follow the proper procedures when hiring an employee.
The IRS consistently warns taxpayers that if they are caught paying ‘employees’ as ‘sub-contractors’, they will pay stiff penalties on top of the taxes and interest owing for payroll withholdings that should have taken place.
Also, what happens if one of your employee gets hurt on the job picking up a delivery or even slipping and falling at your workplace? Can they make a Workers Comp claim that comes to your rescue to pay the medical bills? No. Because you don’t have Workers Comp! You treated them as a sub-contractor and so now you face personal liability and the piercing of the corporate veil because you were negligent in your management of the business and employment practices. This could actually be far more devastating than an audit because claims for medical costs or pain and suffering could easily exceed a tax or penalty.
There are facts and circumstances most commonly used to determine the difference between an employee and sub-contractor. It’s a subjective analysis and some facts may indicate that a ‘worker’ is an employee, while other factors indicate that the worker is a sub-contractor. Thus, you need to weigh the issues with your tax or legal advisor to make the right decision and what path you’re going to take.
Here are the 3 most common factors or categories to analyze are as follows:
The old adage regarding a duck couldn’t be more appropriate. If it looks like a duck, quacks like a duck and walks like a duck- It’s a duck! Same thing with employees. If they act like an employee, are treated like an employee and are paid like an employee- they are an employee!
The Employee Definition: The IRS and State Workers Compensation Agencies essentially define an employer/employee relationship as one in which the employer controls the workspace, the hours worked, the equipment to be used and directs the daily and weekly activities of the worker.
A Sub-contractor by contrast is one that typically carries their own tools, supplies, bills for their time and/or services, controls their hours worked and serve multiple customers or clients and aren’t supervised or directed by one employer in particular.
Bottom line, if they are an employee…deal with it and get the proper paperwork and procedures in place. You’ll be far better off in the long run. PLEASE be careful and make sure you discuss this issue with your CPA and attorney when hiring a worker that may be falling within this grey area. This is not a situation you can ignore or take lightly.
Every week, if not every DAY, one of the attorneys in my office is asked this question in a consultation: "How many properties should I put in my LLC?"
We take this seriously and have to think….Do we want to rip off our client, or give them the answer that is in THEIR BEST interest?
A lot of workshop gurus and ‘coaches’ working out of cubicles in Nevada (supposedly under the guidance of an attorney) will recommend an LLC for EVERY rental. I truly believe this is NOT needed for the far majority of real estate investors. It’s expensive, cumbersome and provides nominal benefit to many clients that just don’t have a lot of equity in their rentals….yet!!
Is there a limit on how many properties you can put in an LLC?
No. You can put as many properties as you want into an LLC…but then we have gone to the other extreme. I don’t want to see my clients with 10 or more properties sitting in an LLC and effectively ‘putting all of their eggs in one basket’.
Yes, if you have one LLC for each property, if there is a problem with tenant or contractor, they can’t break out of that LLC and get to other rentals (so long as they ‘maintain’ the LLC).
But don’t forget the cost!!
However, on the flip side with a bunch of rentals in one LLC, if there is a problem with one rental, they can get at the other 9. So much cheaper…but where is the happy medium and we NEED to be balanced…as in most areas of our lives.
It comes down to Equity, Location and Types of Rentals
In my opinion, the heart of the issue is the amount of equity you have in each one of your properties, where they are located and which properties have the most risk of a potential lawsuit
I’ve always said it comes down to “quality”, not “quantity”. If you have a bunch of low-income housing rentals that cash flow, but don’t have a lot of equity, throw 5-7 of these properties in the same LLC. If there is a problem, YOU are protected, and will a plaintiff want to chase down some measly equity in some low-cost rentals- not usually…in fact, VERY rarely.
But if you have a golf course rental, a multi-unit rental, or commercial rental with some significant equity, that property may very well deserve its own rental. Another way of saying it is to keep your “high equity properties” separate from your “high-risk properties”.
Next, we often find it more affordable and simple ‘group’ properties in LLCs by State, and potentially have a separate LLC for each bundle of properties in every State. This can make banking, foreign filings fees and Registered Agent fees more efficient to manage and save some administrative costs.
Finally, if you DO have properties in multiple states, if the Series LLC is available in that State, it can dramatically increase your protection for a nominal cost.
Finally, this ‘consideration’ and issue is the perfect topic to discuss in an annual ‘asset protection review and strategy session’ with your business attorney. If they don’t bring this topic up to you, or have the ability to help you in multiple states, you have the wrong lawyer.
But no matter what you do…DO NOT rely on some ‘coach’, online service, or real estate sales company for your legal advice on this topic! Oh….but that’s right, if you get into a lawsuit I’m sure they carry malpractice insurance and will stand behind their advice if there is a problem – NOT!!
Ok…so the real name of an IRA that can be used for education expenses is called a Coverdell Education Savings Account (Coverdell ESA). However, for simplicity sake, we in the accounting world generally refer to these powerful little gems as the “Education IRA”.
Regrettably, not everyone in the accounting world believes the Education IRA to be a precious gem. Mostly because they don’t understand their hidden benefit and strategy. Thus, in my opinion, the 529 college savings plans are oversold to the public and no one really talks about the Education IRA.
Let me set the record straight and share what I think to be one of the most incredible ways to save for college education. First, the good news:
The Hidden Strategy. The little known fact that can transform your college savings account/Coverdell ESA/Education IRA into a powerhouse for college savings is the fact you can self-direct the investments. Hence, you can use leverage and sometimes make a small investment that can pay enormous returns and in turn accelerate your college savings account very quickly.
What is a Qualified Education Expenses? Essentially, this term means tuition, fees, books, supplies and equipment required for study at any accredited college, university or vocational school in the United States and at some foreign universities. However, the money can also be used for room and board, as long as the fund beneficiary is at least a half-time student. Off-campus housing costs are covered up to the allowance for room and board that the college includes in its cost of attendance for federal financial-aid purposes.
In summary, many a parent understands the seriousness and stress ‘college savings’ can place on a family. However, just as a retirement savings plan, the best strategy is to just start saving now, and in my opinion, start self-directing your Education IRA as soon as possible to reap the highest possible rates of returns. As a parent with 3 kids in college this year, let me encourage you to take this seriously and just get started with something and don’t give up.
As many of you know, I recommend to ALL of our clients to purchase at least one rental property a year for tax planning and wealth building benefits. It doesn’t have to be big, but at least something. I have created these “10 Steps to Purchasing Your First Rental” as a guide for many of my clients that are new investors. I hope this may even help some of you that are seasoned investors.
HERE is my AMAZING, yet SIMPLE list:
1. Make a Goal.
Set a deadline to purchase your first rental. Stay committed. Let friends and family know your goal. Write it down and set short deadlines to be looking at property and making decisions, rather than just ‘buy rental by X date’. Set more manageable goals to get you to closing.
2. Start Shopping.
Just get out and start looking at rentals. Engage two or more realtors or investors in the markets you are looking at to send you leads and options. Once you start looking you’ll get more motivated and the juices will start flowing.
3. Get a Spreadsheet.
Develop a spreadsheet, even if you have to buy one OR create one, to analyze your properties. This should set forth criteria to ‘rate’ your possible properties by rent rates, operating costs, debt service, property management, etc.. and create an ultimate ROI or Return on Investment calculation.
4. Look at lots of Property.
Take your time and look at lots and lots of property. There is NO RUSH. I have told clients time and time again, there will always be a deal next week. Follow your gut and don’t get sucked into a deal you don’t feel good about.
5.Make an Offer and Start Due Diligence.
Once you find a property that ‘fits the bill’, make an offer contingent on due diligence. If you don’t like the deal…get out. Don’t get emotionally attached to the transaction.
6. Do more Due Diligence.
Look at the property from every angle. Learn how to do good due diligence. Read books and talk to others on nightmare experiences so you can look for any possible problems. Be patience, but DON’T GET discouraged.
7. Open Escrow.
Once your happy with your due diligence and the property looks like a winner, start reviewing docs, move to closing and begin forming an LLC. In MOST states I will always recommend an LLC to hold your rental. Get a consult so we can discuss the matter and help review docs if necessary. Don’t do your first deal on your own.
8. Close and Deed the Property to an LLC.
Don’t stress about closing in your own name or having the LLC finished before closing. There are only a few states where this is important to consider. When we have a consult, we’ll indicate if there is going to be transfer tax problem later. Don’t worry about the ‘due on sale clause’ when deeding to your own LLC. The bank is worried if you transfer the property to someone else after closing, not if you just transfer it to your own entity or trust.
9. Track Expenses.
Keep track of everything for tax purposes. This includes the closing statements, costs you incurred BEFORE you closed and expenses after. Everything related to the purchase and management of the property is a tax-write off. Look at the list at the end of my new CPA book if you need some ideas as to what might be a write off.
10. Manage the property, Tenant AND your Property Manager.
In summary, don’t think this property will run by itself. Stay involved. Take lots of regular pictures. Keep good records on your tenants, and your property manager if you are using one. Visit the property regularly.
With all of these risks and steps to take, I still feel strongly this can be one of the the secure paths to retirement. With the power of leverage and using the bank’s or other people’s money, you can increase your net-worth dramatically. Don’t rush…take your time and realize it’s not a sprint, but a marathon.
The NEBDG Blog, by our Tax & Legal instructor Mark J. Kohler, is "The Real Estate Investment Conversation You Can Rely On." Mark J. Kohler is a CPA, Attorney, Radio Show host and author of the books “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions” and “What Your CPA Isn’t Telling You- Life Changing Tax Strategies”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP. For more information visit him at www.markjkohler.com. Let us know if there is a topic you would like to discuss!