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Asset Protection Tips For Texas Real Estate Investors

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					Asset Protection Tips For Texas
     Real Estate Investors

  John Daves & Associates, PLLC
    Charles E. Brown, of counsel
           (512) 346-6000
       john@johndaveslaw.com
Who/What are real estate investors
 afraid of? Lawsuits concerning:
•   Tenants
•   Guests of Tenants
•   Buyers
•   Environmental Contamination
•   Partners
       (Also, costs to defend a lawsuit)
 What Happens If I Get Sued And
            Lose?
• The Plaintiff gets a Judgment against you.
• The “Judgment Creditor” has the right to
  have certain assets of yours liquidated.
• The proceeds from the liquidation go to
  pay the Judgment.
• The Judgment accrues interest.
• The Judgment is good for 10 years and
  may be renewed for subsequent periods.
                  Goal
• Maximum Asset Protection For A
  Reasonable Cost
• Become Unattractive For A Lawsuit
     Why insurance is not enough
             protection.
• Insurance only protects you against covered claims.
• Insurance does not protect you against:

   – Landlord tenant disputes
      • DTPA Claims
      • Property Code Violations
   – Disputes with contractors
      • Remodeling
      • Repairs
   – Environmental contamination
      • Asbestos
      • Lead Based Paint
      • Contaminated Soil
   – Claims by Buyers
      • Structural Defects
      • Undisclosed Conditions
    Real Estate Asset Protection You
              Have Now
•   Homestead
    – Urban
        • not more than 10 acres of land with improvements
        • located within the limits of a municipality or its extraterritorial jurisdiction
          or a platted subdivision; and
        • served by police protection, paid or volunteer fire protection, and at least
          three of the following services provided by a municipality or under
          contract to a municipality:
              –   (A) electric;
              –   (B) natural gas;
              –   (C) sewer;
              –   (D) storm sewer; and
              –   (E) water

    – Rural
        •   for a family, not more than 200 acres with the improvements
        •   for a single, adult person, not more than 100 acres with improvements
           Homestead Limitations
•   The size of the homestead is limited. (acreage)
•   The value of the homestead is not limited.
•   Only get to claim one homestead.
•   May have a lien against homestead for:
    –   Mortgage
    –   Taxes
    –   Construction work and material
    –   Reverse mortgage
    –   Home equity loan
    –   Divorce lien
    –   Refinance tax debt
      Personal Property Protected
             (“Exempt”)…
• Personal Property
   – Married Couple - $60,000 aggregate
   – Single Adult - $30,000 aggregate
• Categories
   – (1) home furnishings, including family heirlooms;
   – (2) provisions for consumption;
   – (3) farming or ranching vehicles and implements;
   – (4) tools, equipment, books, and apparatus, including
     boats and motor vehicles used in a trade or
     profession;
   – (5) wearing apparel;
   – (6) jewelry not to exceed 25 percent of the aggregate
     limitations prescribed by Section 42.001(a);
 …Personal Property Protected
         (“Exempt”)
• Categories (…continued)

– (7) two firearms;
– (8) athletic and sporting equipment, including bicycles;
– (9) a two-wheeled, three-wheeled, or four-wheeled motor vehicle
  for each member of a family or single adult who holds a driver's
  license or who does not hold a driver's license but who relies on
  another person to operate the vehicle for the benefit of the non-
  licensed person;
– (10) the following animals and forage on hand for their
  consumption:
    • (A) two horses, mules, or donkeys and a saddle, blanket, and
      bridle for each;
    • (B) 12 head of cattle;
    • (C) 60 head of other types of livestock; and
    • (D) 120 fowl; and
– (11) household pets.
        Other Assets Protected
•   IRA/ SEP
•   Insurance Policies
•   Qualified Retirement Plans
•   College Savings Plans
   What Is Not Protected From Judgment
         Creditors (“Non-Exempt”)

• Non-homestead real estate
  –   Rent houses
  –   Office Buildings
  –   Apartment Complexes
  –   Duplexes
  –   Vacant Lots
  –   Vacation Homes
  –   Raw Land
• Checking/Savings Account
• Stock in Corporations
• Boats
    Holding title in your name
• No shield to protect you from creditors.
• All of your “eggs are in one basket”.
• Judgment creditors can seize all non-
  homestead real estate.
• All non-exempt assets owned are at risk
  for a claim that originates with one
  property.
Client Lawsuit


                 John Doe and wife, Jane Doe

                        Homestead
                      2202 Castle Rd.

                       Rental Property
                      3200 Maple Street
                       232 Downing Dr.
                       4703 Elm Street

                                               Tenant
                                                 Lawsuit
Don’t put all of your eggs in one
              basket

                          3200 Maple Street




                           232 Downing Dr.




                           4703 Elm Street
Put each property (egg) in it’s own
          LLC (basket)
                         John and Jane
                             Doe
                        2202 Castle Rd.
                          (Homestead)




        LLC #1              LLC #2
                                                LLC #3
   3200 Maple Street,   232 Downing Dr.,
                                           4703 Elm St., LLC
         LLC                  LLC




  Tenants of 3200
  Maple Street, LLC
      Why You Must Act Early
• Fraudulent Transfer Statute – Not allowed to
  transfer assets after a creditor appears.
  – Any transfer after a claim is made or demand letter
    sent is suspect.
  – Not allowed to convert non-exempt assets to exempt
    assets.
  – Courts can look back 2 years.


• Possible Gift Tax for a transfer of assets
• Loss of control of assets transferred to others
    Fraudulent transfers are generally
 indicated by “badges of fraud,” including

• transfers to a family member;
• whether or not suit was threatened before it
  was filed;
• whether the transfer was of substantially all of
  the person’s assets;
• whether there was equivalent consideration
  for the transfer;
               Forms of Ownership

• Individually/Sole proprietor
• In some type of entity
   – Informal – (not registered with state)
      • Joint Ventures
      • General Partnerships
   – Formal
      •   Corporations
      •   Trusts
      •   IRA/SEP
      •   Limited Liability Companies
      •   Limited Partnerships
     Joint Ventures and General
            Partnerships
• Each partner is jointly and severally liable
  for all obligations of the partnership. (no
  asset protection)

• Each partner is liable for all obligations
  incurred on behalf of the partnership by
  one partner (even if they were not aware
  of the obligation).
             Corporations
• Stock is not exempt from Judgment
  Creditors

• Gain on distributed assets

• May have double taxation

• Annual meetings required
                                  Trusts
•   Land Trusts
    - no statutory basis in Texas (allowed however)
    - can help with anonymity but not a liability shield

•   Revocable Trusts and Living Trusts do not provide a shield from
    creditors (a creditor can force you to take property out of your trust
    to pay off the judgment) Living trusts are a probate avoidance tool

•   Irrevocable Trusts – provide liability protection but -
     –   Loss of control – decisions made by a trustee
     –   Possibly higher tax liability
     –   Difficult to operate (e.g. leasing, re-financing)
     –   Expensive to operate
       Asset Protection Trust
• Designed to provide:
  – Privacy of ownership
  – Asset protection

• How it works:
  – Set up revocable trust – use a “corporate
    trustee” that acts as your agent
  – Form LLC with trust as the sole owner
  – Deed asset into LLC
        IRA/SEP (Self directed)
•   Lack of flexibility
•   Difficulty in leveraging with loans
•   Usually a limited source of funds
•   Good for “Slam Dunk” purchases to “flip”
    property
         Limited Partnerships
• Protection from Creditors - Judgment Creditors
  can only get a “Charging Order”
• Partnership “flow through” Tax Treatment
• Limited Partner’s liability is limited to the
  investment in the partnership
• The General Partner(s) are liable for the debts of
  the limited partnership
• Will be used less often in favor of an LLC (for
  cost set up reasons and can be more complex)
 Limited Liability Company (“LLC”)
• Protection from Creditors - Judgment Creditors
  can only get a “Charging Order”

• Partnership “flow through” Tax Treatment

• Members liability is limited to the investment in
  the LLC

• Inexpensive to form and operate
     Charging Order vs. Writ of Execution
      A big reason to use an LLC or LP rather than a corporation:

• Real Estate owned by LLC/LP - Judgment creditors can only
  get a “charging order” – they do not get the real estate, they
  only get funds distributed to the members – IF ANY

• Real Estate owned by a Corporation - Judgment creditors force
  a “turnover” of stock from the Shareholders.

• Also remember: Real Estate owned by Individuals – Judgment
  Creditor can force a sale.
  12 MISTAKES Real Estate Investors
    Make In Protecting Their Assets
1. Procrastinate.
2. Fail to put the asset in the LLC after the LLC is
    formed.
3. Do not sign legal documents in the name and
    capacity of the LLC.
4. Put too many assets in one LLC.
5. Keep the property insured in the individual’s
    name instead of the LLC.
6. Fail to use a Buy-Sell Agreement when there is
    more than one owner of the LLC.
7. Think that they can do anything they want to
    because they are doing business using an
    LLC.
            Tips on #7 above
• Stop doing things that you should not do.
• People who break the law or cheat other
  people deserve to be sued and deserve to
  lose the suit.
 If your property has a dangerous condition - fix it,
                                                disclose
                                                it!
 If your lease has an illegal provision in it - get rid of it!
     The “Grandmother Test”
• If your Grandmother was the buyer or
  seller, would you be handling the
  transaction the same way?
        12 Mistakes continued
8. Breach the “due on sale” clause in their
   mortgage without being able to take that risk.
9. Enter into contracts to buy real estate in their
   name individually instead of using an LLC.
10. Do not read the Company Agreement or
   Partnership Agreement before signing.
11. Re-cycle an LLC after selling a “high risk”
   asset (better to dissolve it and start over).
12. Procrastinate.
              Plan of Action
              What To Do Now
• Property that is owned free and clear of a
  mortgage
  – Form an LLC
  – Deed the Property to the LLC
  – Insure the Property in the name of the LLC
  – Notify all potential creditors and tenants of the
    transfer and that you will no longer be liable.
  – Assign all leases to the LLC
  – Change all accounts to the LLC
  – Use a separate LLC for each property
       Property With A Mortgage
           What To Do Now
• Check for a Due on Sale Clause
• Almost every Deed of Trust has a “due on sale
  clause”

   – If no Due on Sale Clause – take the same steps as if
     the property had no mortgage
   – If there is a Due on Sale Clause

      • Ask Lender if you can transfer title to an LLC/LP
      • Evaluate the risk of breaching the mortgage
        agreement vs. the asset protection to be gained
      • Consider re-financing in an LLC/LP
Why Do We Care About The “Due
      On Sale” Clause?

• Allows the Lender to call the note due
  immediately.

• The Lender can foreclose if the note is not
  paid off.
      Example Due On Sale Clause
“If all or any part of the Property is sold or conveyed without
Beneficiary’s prior written consent, Beneficiary, at their option,
may declare the outstanding principal balance of the note,
plus accrued interest, immediately due and payable. Any of
the following is not a sale or conveyance of the Property:

•   the creation of a subordinate lien;
•   a sale under a subordinate lien;
•   a deed under threat or order of condemnation;
•   a conveyance solely between the parties; or
•   the passage of title by reason of death of a maker or operation
    of law.”
            Acquisitions
• Make purchase contracts in the name of
  your “contracting LLC/LP” or assigns.
• Use an “assignment clause” in the
  contract.
• Form the LLC/LP before closing.
• Make loan application in the name of the
  LLC/LP (Lender may require personal
  guarantee)
• Take title in the name of the LLC/LP.
 When Would I Not Want To Own
    Real Estate In An LLC?
• Lender may require title to be in an
  individual’s name.
• You are exchanging property in a 1031
  exchange that you have owned in your
  name.
• You have no equity in the property and
  you have no assets to protect.
• Property is your homestead.
        Personal Guaranties
• Loans to LLC/LP from a bank will usually
  require a personal guaranty from the
  individual owner of the LLC/LP.
  – Ask to limit the guaranty to a specific amount
    of the loan.
  – Ask to limit the guaranty to a limited time
    period.
  – Avoid signing a guaranty whenever possible.
 Removing The Target From Your
            Chest
• Know what is exempt and non-exempt
• Discourage lawsuits by structuring
  ownership of non-exempt assets in LLC’s
  or LP’s
• Settle cases for less by setting up barriers
  to judgment creditors.
         a




    (512) 346-6000
john@johndaveslaw.com

				
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