To explain how these concepts are applied differently over time, we’re going to focus on three different avatars: a beginner investor, intermediate investor, and advanced investor.
Helping us walk through these stages of life is our panel of experts:
- Pam Maass Garrett of Law Mother
- Bill McIntosh of Complete Protection Insurance
- Byron Elliott of 3 Pillars Law
While our panelists have great information, it’s important to talk to your own team or reach out to them for guidance specific to you.
- Listen to the podcast “#393: Steps New Investors Should Take Today to Protect Their Wealth” Denver Real Estate Investing Podcast
- Watch the YouTube video (at the bottom).
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.
Profile of a Beginner Investor
To illustrate the different investor avatars, we’re going to use me to paint the picture. As a beginner investor, I was self-employed as a real estate agent, had a lower net worth, and no dependents. I owned one rental property, and was doing a flip, too.
The biggest difference between me and most of our audience is that I was self-employed instead of having a W-2 job, but that won’t matter for this topic.
Should I Title My Real Estate in My Personal Name or an LLC?
Byron says that a lot of people like to use Limited Liability Corporations (LLCs) to protect their personal assets. They cost about $100 to set up and require annual reports and a separate tax return.
For flips with partners, Byon and Pam both recommend setting up an LLC. In these business arrangements, multiple people are contributing money and incurring debt. Each partner is liable for decisions the other one makes, so it’s important to protect your personal assets. An LLC and operating agreement with clearly defined roles and expectations is the most favorable arrangement.
The biggest mistake Pam sees when creating up LLCs is people making one online that isn’t set up properly. They don’t realize that their estate will go through probate if they die, which is timely and costly.
If I Buy a Property in My Personal Name, Should I Transfer It to an LLC?
Many investors take advantage of low down payment options by buying real estate in their personal name with a 30 year conventional loan.
Byron says that if you want to put that property in LLC, you need to plan for it ahead of time. It’s very difficult to transfer property that’s subject to a mortgage into an LLC. There’s usually a clause in the mortgage document that states such a transfer would trigger a due on sale clause, allowing the bank to call the loan.
None of our experts have seen a bank act on this. Generally, if you keep your mortgage current, you’re the last thing on their priority list. However, it’s a risk investors should be aware of.
Does Good Insurance Coverage Eliminate the Need for an LLC?
Back when I was younger, I didn’t create an LLC for my rental, but I had a high landlord insurance policy for $500K with an umbrella on top of it.
Bill says that everyone with insurance wants to think they’re covered. But when something bad happens and a jury is hearing the story of the person wronged, an umbrella policy probably isn’t going to cover enough assets.
For example, a few years ago Bill saw a case where someone was in an accident with a semi-truck and they sued the company for $14MM. Umbrellas go that high, but beginner investors can’t afford them. An LLC prevents all of your assets from being on the table, which is why he advises clients to get them as soon as possible.
How Does Insurance Coverage Work with an LLC?
Until you have 20 properties, you can use your personal insurance to cover you. As you add to your portfolio, your umbrellas should get bigger, to say $1MM, $2MM, or even $5MM. The LLC will protect your personal assets if something really bad were to happen.
What Should I Know about Insurance in Colorado?
Pam reminds us that every state has its own sets of laws. Colorado is a premises liability state, meaning property owners are responsible for what happens on their property. It doesn’t matter if the title is held by an LLC in another state if the property itself is in Colorado.
Similarly, owners have a non-delegable duty to protect people on their property. For example, even if you hire a snow removal company but a tenant slips and falls on ice, you can still be sued as the property owner. This is why you want good insurance to cover you, provided by an agent like Bill who can explain all of the details and risks.
What’s a Good Insurance Stack for a Beginner Investor?
When I started investing, my rental property wasn’t in an LLC and I was flipping some houses.
Bill recommends homeowner’s insurance on my primary residence along with auto insurance. As a real estate agent, I take people in my car to look at properties, so I want a high limit. I’m allowed to call this activity business use in my policy and then put an umbrella on top of it. Umbrellas are pretty inexpensive, at about $300-$500 a year for a $1MM policy.
For flipping properties, he recommends a homeowners insurance policy on the property while it’s being flipped. If it’s a small flip, regular landlord property insurance is fine. However, once actual construction is involved, like moving walls and adding square footage, that will change the type of policy recommended. This is why it’s important to talk to an agent who can walk you through these details.
Should I Worry about How Many Insurance Claims I Make?
As a beginning investor, it’s not always a good idea to file a claim instead of paying for things out of pocket. If there are small items that you can afford to pay for, it’s generally better in the long run to do that. The more claims you make, the more expensive your insurance becomes. As you acquire more properties, you don’t want your insurance to become prohibitively expensive.
What Should I Do with My Primary Residence?
Since a primary residence is for personal use, it would not be put in an LLC. However, it’s a good idea to put it into a living trust. A living trust is a core foundation of estate planning and protects your property for your heirs. A living trust is seen as an extension of you, and making sure the trust is revocable allows you to make changes and maintain access.
If I Don’t Have a Lot of Assets, Do I Need an Estate Plan?
Creating an estate plan versus a will comes down to risk tolerance. Pam doesn’t advise her clients between estate plans and wills based on their net worth. Rather, she explains what will happen and asks them how they feel about it.
Looking back to when I was a beginning investor, I didn’t create an estate plan because I didn’t have kids yet and I didn’t have a lot of assets. After setting up my estate plan with Pam, I regret not doing it earlier. It’s much easier to pay a little more upfront to create a plan that can grow with you. Instead, I had to spend more time and money later sorting out and structuring everything correctly. If I’d set it up properly back then, I’d be in a much better position today.
Connect with Our Experts
To reach out to our experts directly, contact them here:
Pam is offering a free copy of her book Legally After Ever that shows parents how to create an estate plan that will protect their children. Use the promo code RICO to download your copy today: https://lawmother.com/freebook/.
These are complex topics full of nuance, and we can’t cover everything in three episodes. We plan to make this a recurring series based on the questions you have. Drop your questions on LinkedIn and Instagram and we’ll answer them in a future episode.