Two More Real Estate “Gotchas” to Avoid

March 01, 2010

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As if we didn’t have enough real estate worries between mortgage defaults, property devaluations, and commercial property woes, here are two that are often missed even by those who pay their bills on time: Liability Protection and Out-of-State Ownership issues. Two of the main attractions of real estate—the ability to use the asset and the ability to “get away” to another place — require a very different level of liability and estate planning to protect yourself and your future plans for the asset.

Liability Protection
Consider this scenario: You receive a letter from the attorney of the family who rented your beach house. One of their children stumbled off the deck and suffered neck injuries resulting in a lawsuit. You have liability coverage, but if they win a judgment that is greater than your insurance coverage limits, your personal assets are at risk. Property insurance and an excess liability insurance policy should be coordinated and integrated by an insurance professional to ensure proper coverage. Clarify whether the excess liability policy actually covers the out of state property, and if the property is owned by a separate legal entity, is the entity correctly listed in the policy? Even a well-designed insurance plan may not be enough to stop someone from suing you for more than your policy covers—and everything else that you own.

Fortunately, there are safeguards to further protect yourself from liability claims. By transferring real property to a properly structured Partnership or Limited Liability Company (LLC), you may be able to benefit from the liability protection advantages of these types of entities. Typically the assets outside the Partnership or LLC would be protected while only the real estate titled in the entity’s name remains at risk. Other entities such as C Corporations and S Corporations may also provide liability protection. Consult with an experienced attorney to determine which entity structure best suits your liability protection needs.

Out-of-State Ownership Issues
Without careful consideration, out-of-state property could potentially wreck even a wellexecuted estate plan as states have different death tax laws and laws of descent. Knowing how these laws affect your properties and your estate plan is critical as real estate that passes through your will must go through the state probate process, becoming a matter of public record.

For example, you may own farmland in another state that’s been in your family for generations. Even if your will includes detailed instructions for passing this land to the next generation, unintended consequences may arise as the out-of-state farmland passes through probate in the state where it is located – not in your state of residence. State laws of descent could divide the property unevenly, or the estate may lack liquidity to pay for that state’s death taxes. A forced sale of the property at an unfavorable price could be the beneficiaries’ only option.

Creating a Revocable Trust or Title-Holding Trust (Land Trust) to hold real estate may avoid the probate process, allow control over the distribution of the asset, and protect the beneficiaries’ privacy. Partnerships and LLCs may be passed through a Revocable Trust, addressing both liability and estate planning concerns. A unique feature of an LLC is the ability to make heirs non-voting members, then use your annual gifting exemption to transfer the property while methodically removing the assets in the LLC from your estate. As always, discuss these concepts with an experienced attorney who can help you structure your estate plan to accomplish your goals.

Whether you own a relaxing mountain cabin, an apartment complex, or just raw land, real estate can create significant problems without proper planning. Make sure you spend the appropriate amount of time and money to protect your investment. This means getting your legal and financial professionals involved before there is a problem. Addressing these details now could make the difference between having a future plan for this asset, or wishing you never owned it.