This article was presented by LegalZoom.
Maybe you’re just getting started in real estate investing with your first property, or maybe you’re a little more experienced and are currently renovating some units.
No matter where you are on your investing journey, if you’re a small-scale real estate investor, it can seem like the whole “setting up a LLCThe aspect of it doesn’t apply to you. It may seem excessive and too time-consuming for what it’s worth. Isn’t it such a big deal, legally speaking, after all, to put on a new coat of paint and improve a few things in an older unit before renting it out?
The truth is that many small real estate investors underestimate this how many legal exposure comes by renovation work. It’s not the size of your investment that you need to think about setting up an LLC– it is the kind of investment.
If you invest in a turnkey property through a company, you may be off the hook because someone else owns that liability (more on that later). But if you manage the renovation work yourself, even for a single investment property, the potential benefits are significant.
Here’s how LLCs protect you from renovation liability claims.
Common legal disputes during renovations
First, you may be wondering, “How bad can it really be?” Here’s a taste of what can go wrong on a renovation site and lead to a liability claim:
- A contractor is injured on site and sues the owner.
- A subcontractor files a mechanic’s lien.
- A renovation causes damage to a neighboring building.
- A flip buyer claims undisclosed defects.
- A dispute over a supplier contract escalates.
- Poorly drafted rehabilitation agreements lead to exceedances or non-performance.
- Unlicensed work creates liability upon resale.
As you can see, there are a lot of legal “unknowns” that come with a renovation project. Your largest The risk often does not lie with the property itself, but with the vendors and subcontractors who carry out the work. They can sue you if something happens to the builders on site, but they can also sue much later when the renovation work takes place. has not been completed to standard.
This is by far the riskiest aspect of renovation work That the legal side of things (WHO owns the responsibility for what) is often vague and complicated. The more subcontractors who are involved in your project, the greater the risk that someone work does not have the correct qualification/licence on site, which may be the case enormous implications. It can only be one plumber/installer.
Not all states require contractors to have a specific warranty; instead they make vague demands along the lines of “suitability for the intended use and habitability” (A Michigan example). If a structural defect is discovered after a sale and you are sued by the new owner, and the contractor’s warranty does not cover you, you will be liable.
Filing liens can be disastrous for a real estate investment. When a contractor orders renovation materials, the supplier has a lien on a part of your home equal to the cost of the materials. If a contractor, for whatever reason, does not pay the supplier, the supplier can sue you costsor, in the worst case, force the sale of the property to cover their debts costs.
Multifamily investors should do that be prepared for costly lawsuits from residents who at some point discover that they live in a building that is has been insufficiently or incorrectly renovated. For example, if you own an apartment, you could be sued for a flooded communal parking garage (a real case in Florida) or an under-renovated lobby. Again, depending on your local legislature and the exact building, i.e. building developer, or it could be you, the owner filed against.
The right question is not, “How likely am I to get sued?” but “How much complexity is involved in my renovation?” The more complex the renovation project, the more problems you may encounter come in if anything it’s fine wrong.
How Owning a Personal Name Increases Liability
Very simple: if If you own a renovation home in your own name, you are responsible for any legal claims made against you. You could then lose everything you own, including your savings, other investment properties you own or even your home.
Your business liability insurance does not coverage for all contractors working on the renovation of your investment property. You may have heard of taking out a “Builder’s Risk” type policy, and it is true that it will be so cover personal injury or accidentalto you or your tenant/a visitor, but again, not to any contractor or subcontractor working on the property. Contractors must be covered by their own insurance.
You also can’t use personal liability insurance to pay investment-related claims; you must take out premises liability for everything related to investments.
As an investor you do not have much choice if you own your investment property under your own name. You are legally responsible and there is little recourse if something goes wrong during or after a renovation because insurance does not cover workers on your property.
Why an LLC Creates a Legal Boundary Between Rehabilitation Risk and Personal Assets
When you form an LLC for your investment properties and the renovation contracts are between the contractors and the LLC and not you personally, any legal claims in connection with the property can only be filed against the LLC, not against you personally. This means that your personal assets (own home, savings, car) are protected; only your business assets (for example, another investment property under your LLC) are open to claims. Even if a liability claim results in you having to pay the plaintiff, the plaintiff can’t go after your personal assets if you don’t have enough business assets.
Considering how easy it is to set up an LLC, this is a no-brainer for any real estate investor. However, you must do them diligently and conscientiously.
If you start mixing personal and business expenses, for example by using your business bank account for your personal accounts, you’ll be violating that legal LLC shield, potentially opening up your personal assets to lawsuits after all. But as long as your LLC is run correct, it protects you. You also don’t have to run a business to form an LLC; you can get one Single-member LLC.
How LLCs Work with Insurance
Despite all the benefits, setting up an LLC doesn’t mean you don’t have to get insurance on your investment properties. There are many scenarios where having an LLC will not protect you from a claim. For example, you still need home insurance to protect you against natural disasters and hazards such as fire.
Or let’s imagine another, much more common renovation scenario: someone visits the property while you are there during the renovation, and slips and falls. They can still sue you personally, and if the court finds that the accident was the result of your own personal negligence, you could still lose your personal belongings. That is why building insurance with a Builder’s Risk Policy is still essential.
Why investors doing value-added projects should do so Always Provide entity protection
These are investments with added value Through their nature more more complex than ready-made investments. Even more can go wrong, both during and, crucially, after the renovation. In some cases even after you have sold the property.
Think of an LLC as that essential shield against “unknown unknowns”: you Ordinary cannot predict or avoid every event due to the many parties involved, so it is essential to protect your personal assets from any claims you may have have been exposed Unpleasant.
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