Asset protection for landlords

Rent it Right

By Inman News Feed
Add Comment Add Comment | Comments: 0 | Posted Apr. 9, 2010

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Rent it Right

Janet Portman
Inman News

Q: My husband and I are going to rent out my parents' home, which I have inherited. How can we best protect our personal assets from lawsuits or other claims that might arise during our landlording business? --Fred and Delia J.

A: The best way to avoid trouble is not to invite it. If you learn the rules surrounding the business of being a landlord -- and there are many, on the federal, state and local level -- your chances of being sued or having to deal with unexpected expenses go down.

Similarly, if you use written contracts with vendors and tradesmen, the chance that you'll have a dispute concerning the relationship that boils over into litigation will be lessened. Combined with adequate insurance, this offense is your best defense.

But sometimes, despite your best efforts, things go awry. Many landlords in your position want to shield their personal assets from judgments or settlements, and many people automatically think of forming a corporation. True, a corporation will protect your personal assets (as long as you segregate your personal assets from the business assets), but forming and running one is time-consuming and expensive; and you'll have to file a corporate tax return.

Alternately, you could form a limited liability company (LLC), which will give you the same protection as a corporation, but not require regular board meetings and minutes. You can also pay taxes through your individual tax return, an option not available to regular corporations.

Don't assume that once you form an LLC for your business, your personal assets will never be at risk, however. Lenders and creditors (vendors) understand that people form LLCs precisely to protect their personal assets -- and to limit the creditor's ability to collect -- should the LLC fail to pay a bill or a loan.

And why should the bank or vendor agree to such a limitation? The short answer is that they won't. Instead, they will probably ask you to personally guarantee loans or the extension of credit to your LLC. This guarantee means your personal assets are at risk despite the LLC structure. In other words, it destroys the limited liability the LLC would otherwise provide.

On the other hand, with an LLC your personal assets will still be protected from claims for personal injuries and violations of the fair housing laws. This protection holds only if you've run your LLC as a business entity that's truly separate from your personal business, however.

If you are sloppy, commingling funds, failing to keep separate books and otherwise disregarding the legal rules concerning LLCs, you may lose the protection you sought.

Q: I rent an efficiency unit for $399 per month. Written into my lease is a late-fee clause stating any late rent is subject to a $75 late fee with additional charges per day of $5, capping off at $100.

I work at a company that has recently significantly cut my hours, and this has made it impossible to pay my entire rent on the due date. So I have been paying half and waiting two weeks to pay the other half. But then I get hit with an additional $100 late fee.

I know I have to pay my rent on time, but $100 seems exorbitant on my small unit. Can I ask a judge to rule that it's not legal or fair? --Yolanda S.

A: You're looking at a 25 percent late fee! You certainly do have some arrows in your quiver. But before turning directly to your question, let's review the rules.

Late fees are legitimate when they compensate the landlord for the actual loss suffered as a result of a tenant's tardy payment. Such losses include the cost of reminding the tenant to pay (by sending a pay-or-quit notice, for example), the staff time spent trying to collect, and the interest lost on that money for the days it doesn't spend in the landlord's bank account. Late fees that exceed actual damages are legally considered penalties, which are not valid in consumer contracts (including leases and rental agreements).

Many states recognize that it's not easy for landlords to accurately measure the losses they will incur. These states allow landlords to include a set late fee in the lease, but the fee must still follow the universal rule explained above, by being a close approximation of what the landlord will in fact lose if the rent is late.

For example, in Delaware, Maryland and Oregon, the fee cannot exceed 5 percent of rent; in Iowa, late fees cannot exceed $10 per day or $40 per month; North Carolina will invalidate a fee that is higher than $15 or 5 percent of the rental payment, whichever is greater; and New Mexico and Tennessee, at the high end of the list, cap the fee at 10 percent.

Some states, like Texas, require a late fee to be "reasonable," but that is simply another way of saying that the fee must closely approximate the landlord's damages.

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