Later this month we’ll be doing a Zoom presentation that covers the process for protecting your hard earned rental properties from creditors using Texas LLCs.
This purpose of this blog post is to answer some of the common client questions we get about using LLCs to protect rental properties from creditors.
Please be sure to speak to your attorney for customized advice for your specific situation when protecting rental properties from creditors.
The blog post covers general rules but as always there are exceptions that can apply to your specific case!
How Do You Create a Texas LLC?
Think of it as a Texas two-step! Step 1: prepare a valid company agreement. Step 2: file the required paperwork with the Texas Secretary of State along with required fees.
You will get a Certificate of Formation documenting the creation of your LLC along with an identifying number for the LLC with the Secretary of State.
Be sure to pass the XT number from the Texas Comptroller to your CPA so your CPA can file annual Texas Franchise tax returns to keep your LLC in good standing.
How Do You Move Assets Into the Name of Your LLC?
At minimum your LLC should have its own checking account. Your attorney or CPA can fill out an online IRS EIN application so your LLC is operating under its own tax ID instead of your personal SSN for business purposes.
For rental property, you will file a deed in the county property tax records where the rental property is located to document that the property is now owned by your LLC.
Other people who should be involved:
- CPA – let them know the real estate is now in the name of the LLC.
- Property / Casualty insurer – be sure that your property insurance company updates their records to show the LLC as the property owner and that the right type of property insurance is in effect.
- Mortgage company – be sure the mortgage company will not trigger a mortgage acceleration clause if you move the rental property into your LLC. This is usually best handled before you create an LLC.
What Are Some Non-LLC Ways to Protect My Rental Property From Creditors?
Standard good practice:
- Be sure you have the right type of insurance for your rental property. Homeowner’s insurance and rental property insurance are different policies and you want to make sure you are covered if your tenant causes a fire.
- Consider higher than normal property insurance limits. Many landlords also buy an umbrella insurance policy that increases limits to $1 million or more.
- Screen tenants carefully. The background and credit check is worth the money. An excellent tenant at slightly below the market rate may be better off in the long run than a market rate tenant that trashes your property.
- Always, always, ALWAYS get a written lease and enforce the terms of the lease and document what you are doing in writing in case (heaven forbid) you are dragged into small claims court for a tenant complaint.
- Consider hiring a reputable and competent property manager.
If I Follow Good Practices And Have Good Insurance, Do I Still Need an LLC?
Imagine you get in a car wreck with a Fortune 500 executive.
The executive gets a judgment against you far in excess of your auto policy coverage alleging that he cannot work so you owe him lost wages.
If your rental property is in your sole name (e.g., not in an LLC), the Texas Property Code does NOT classify rental property as an asset that is exempt from seizure by creditors.
In contrast, if your rental property is properly in the name of a properly managed and maintained LLC (more on that during the video presentation) then the executive’s exclusive remedy against your LLC ownership is a “charging order.”
A “charging order” is a fancy way of saying that the Fortune 500 executive has limited rights to your LLC interest. The LLC executive:
- CANNOT force you to sell the rental property that is owned by the LLC
- CANNOT use your LLC ownership to change the managers or management of your LLC
- CANNOT use your LLC ownership to trigger withdrawals from the LLC’s checking account to pay the judgment
The LLC executive is limited to waiting around for when you decide to take withdrawals from the LLC. His charging order lets him seize any withdrawals you are entitled to from the LLC but no more.
In this example, as LLC manager, you would probably drag your feet on signing off on any LLC distributions.
Litigation attorneys know about this “charging order” provision under the Texas Business Organizations Code and would prefer to get checks from insurance companies instead of trying to breach an LLC’s liability shield.
What Can Go Wrong With an LLC?
The example above assumes the LLC is being run properly. A property run LLC includes but is not limited to:
- The LLC is in good standing with the Texas Comptroller and has filed all of its Texas Franchise tax returns.
- The LLC is being properly run as a separate legal entity with its own checking account and properly managed internal documents.
- The assets that should be protected by the LLC’s liability shield are ALREADY in the name of the LLC (e.g., checking account, real estate) long before any event causing liability occurs.
How Are LLCs Taxed? Can I Get a 20% Pass Through Entity Deduction for My LLC on My Federal Income Taxes?
At the risk of putting some viewers to sleep, we’ll be covering the income tax issues for Texas LLCs during our Zoom presentation!
Your author confesses to being a tax nerd and acknowledges that others may not share his interest in paying the lowest amount in federal income taxes legally allowed!
I hope this QA blog post has been helpful! If you would like to know more about using Texas LLCs to protect your rental properties, please attend our Zoom seminar later this month!
Attorney, Board Certified in Estate Planning – Texas
Certified Financial Planner
TCV Law Group