The suicide squeeze is one of the most exciting plays in baseball.
It happens when there’s a runner on third who takes off toward home when the pitcher starts his motion, expecting the batter to make some sort of contact with the ball and put it in play, thus scoring a run.
Except for trying to steal home outright it’s also the riskiest play in baseball.
I was with a couple of buddies this afternoon smoking cigars and talking shop. We got on the subject of rental houses, and since one of them is a lawyer, we talked at length about how many LLCs I use with my rentals and how I learned to use them properly.
He then told me about a couple of his colleagues that have free-and-clear rental houses. They’re building up portfolios, and his understanding is that neither of them use LLCs at all, as they were simply holding the properties in their own names.
That’s just about the riskiest play in landlording.
Which is why I call doing that it the Landlord Suicide Squeeze.
Why? Because when you do that you’re betting your entire personal balance sheet on black.
Every single day.
All it takes is one slip and fall or one “accident” at one of your properties and you could be committing personal financial Hara-Kiri.
Now I know the folks he was referring to, and they’re both really smart people. Which reinforces to me the fact that proper use of entities isn’t common knowledge.
So I want to use this space to review the reasons why using entities is important when you have rentals.
One caveat – my friend is a lawyer, I’m not. So I’m not giving you legal advice. If you have questions, talk to a local attorney with real estate entity experience.
Here are three items to keep in mind:
1. You need to limit your liability
This is the most important reason to use entities. Whether you choose to actually incorporate each property, or keep each one in an LLC is up to you. The important thing is to just do it.
The reason is simple.
If you have say four rental houses, and if you keep them all in your name and a tenant or neighbor has some sort of accident at one of them, since there’s no wall of separation between your properties individually, or between your properties and your personal financial life, you can potentially lose everything.
Your rentals and anything you have of value personally – your home, your investments, your savings accounts, etc.
If you instead hold each of your properties in a LLC, and there’s an accident at one of them, your liability is limited to the amount you have invested in that LLC and your personal assets would be safe.
So entities are critical to your financial well-being if you own rental properties.
2. You need to treat each entity as a stand-alone business
This was an eye-opener for me when I talked to my attorney about it.
The reason is that most people move money back and forth between entities, and they do other things that don’t treat each entity as a stand alone business.
My attorney told me that doing this lessens the protection that an entity gives you, and thereby increases the likelihood that your entity could get “pierced” in a legal action.
NOLO Press says this about piercing an entity:
“If a court pierces a company’s corporate veil, the owners, shareholders, or members of a corporation or LLC can be held personally liable for corporate debts. This means creditors can go after the owners’ home, bank account, investments, and other assets to satisfy the corporate debt.”
NOLO Press states that there are three reasons why a court will piece an entity. They are:
1. There is no real separation between the company and its owners.
2. The company’s actions were wrongful or fraudulent
3. The company’s creditors suffered an unjust cost
After going through the time, effort, and energy to create entities for your rentals, having one of them pierced is obviously not something that you’d like to see happen.
For a lot more detail on entities getting pierced, I recommend you visit NOLO Press and read up on it. You can find the information here: http://www.nolo.com/legal-encyclopedia/personal-liability-piercing-corporate-veil-33006.html
3. You need to have adequate insurance coverage
While this doesn’t necessarily involve entities, it can help mitigate the risk of having one pierced.
My insurance agent, my attorney, and my CPA recommend a General Umbrella Policy in an amount sufficient to cover your entire portfolio. It’s relatively inexpensive. Talk to your insurance agent to determine what the right amount is for you.
If you implement these three things, you’ll do a lot to limit the potential liability you could face if some sort of accident occurs at one of your properties.
But the time to do it is before it happens. So you don’t experience the Landlord Suicide Squeeze.