Hello. My name is Kyle Krasa and I’m an estate planning attorney in Pacific Grove, California. I’m certified by the state bar of California, as a legal specialist in estate planning trust and probate law. The purpose of this video is to give you general information about an important aspect of estate planning law so that you can be prepared when working with your own attorney. Watching this video does not establish an attorney client relationship. The law is far more complex and nuanced than can be explained in a few short minutes. As a result, before acting on any of the information contained in this video, you should consult a competent attorney who is licensed to practice law in your community. With that understanding, I hope you enjoy my video and you find it informative. Thank you.
When thinking about asset protection involving LLC planning, you want to think about dividing your assets into two broad categories: your personal assets on the one hand, and then your investment and business assets on the other hand.
So let’s think about the personal assets for a second. Personal assets would include your home, checking, savings account, whatever accounts you need for basic daily living expenses, your personal automobile, those kinds of things would all be personal assets.
On the other hand, you might have some business or investment assets, um, assets that you’re trying to make money in the long run. This could be stocks and bonds, could be a brokerage account. It could be, um, real estate, could be a vacation home, rental property. Let’s use rental property, um, as the example here. So let’s say you have a rental and maybe you also have a bank account associated with that rental. That’s the account that you dedicate to, uh, use, uh, with your rental property. That’s the account that you deposit the rent checks from the tenant into, that’s the account that you use to pay for the expenses of the property, property taxes, maintenance, insurance, whatever the case might be, mortgage payments and so on.
So the problem is, and if you don’t have any asset protection planning in place at all, there’s no legal distinction between these two categories of assets. And particularly with a rental property, there’s a lot of liability there because you’re not controlling who is at the property and you’re not controlling the behavior of those people who are at the property. So somebody could get seriously hurt on the property. Somebody could die on the property and the injured party or the family members of the deceased party are going to sue you as the owner of that property even if you didn’t do anything directly. So if there’s a creditor that results from the rental property that creditor can go after the rental property itself or the bank account associated with the rental property. The problem, if you don’t have any LLC planning in place is the creditor can also go after your personal assets as well. There’s no barrier, there’s no distinction. So the creditor, even though the creditor only had a claim against the investment and the business property itself, in this case, the rental property, the creditor could still go after your personal assets. Now, hopefully you have insurance and hopefully the insurance will cover most kinds of liabilities, but there is the possibility that the liability could exceed the coverage limits or that the insurance might not cover the particular incident. Sometimes that happens as well. So many people might worry about not having enough coverage and the insurance might not be bulletproof and they’re looking for an extra layer of protection.
And so one way that they can get an extra layer of protection, especially in the situation like with a rental property, is to form an LLC. Now, an LLC is a business structure. It stands for limited liability company and, uh, you would form it with the secretary of state and really any of the 50 States that you choose. And there are reasons to choose to, uh, certainly one jurisdiction over another, which we’ll talk about in a moment, but you form it with the secretary of state and there’s an operating agreement. There are initial minutes, there are other things that you needed to put together. And then the key part is you need to make sure you title the rental property into that LLC, and you title, maybe the bank account that’s associated with the rental property into that LLC. And now what you’ve done is you’ve created this structure.
And if there’s a creditor that has a claim against you, only because you happened to own the property, they have a claim against the LLC property itself. They’re known as inside creditors. They have a claim inside the LLC. So they can go after the LLC assets, the rental property, the bank account associated with it. But what they can’t do, if the LLC is set up properly, is they can go outside and go after your personal assets. So there’s a barrier there preventing the inside creditor from going outside and going after your personal assets. It’s called piercing the veil. They’re not able to pierce that veil. This veil of LLC protects against that. So they can go after the LLC assets, but they can’t go after your personal assets. So the name is really quite descriptive: limited liability company. It means the liability is limited. It’s limited to only what is in the LLC itself. It limits them, prevents the creditor – that inside creditor – from going after your personal assets.
You’ll get this kind of protection in all 50 States. So no matter what state you form the LLC in this is the essence of LLC protection. The question is, what about the reverse? What about the reverse? Let’s say that you have, uh, you did something you got into a car accident, or you had a health bill that exceeded your insurance, or you had a bad business deal that had nothing to do with your LLC property. And now you’re liable personally. And that case, that kind of creditor is called an outside creditor. They, they, the outside credit does not have a claim again, arising out of that LLC property at all. It’s, it’s a claim arising out of personal actions. In that case, the outside creditor can go after your personal assets. The question, is can that outside creditor go inside and go after your LLC assets?
Well, the answer to that question is it depends. It depends on what state the LLC was formed under. Um, if the LLC was formed in the majority of States, like my home state of California, then yes, the outside creditor would be able to pierce the veil in this direction and go after the asset. So there’s this distinction: inside creditor can go after the LLC assets, but can’t go outside and go after your personal assets and outside creditor, a creditor has a claim against you personally, can go both directions: can go after your personal assets and can go after your LLC assets. Now that’s not the result in every state.
In certain States like Wyoming, Delaware, Nevada, those States only provide, they don’t allow the outside creditor to go inside the LLC. Instead, what they do is they provide a very specific remedy and it’s called a charging order. And this is a lien that the creditor would have. So they can’t go in and capture these assets. All they can do is put a lien on the LLC assets. And basically just hope that you’re going to distribute. You’re going to take out some of these LLC assets and give it to yourself personally. And once you do that, then the outside creditor can get it. Now, of course, if you had this issue, if you had an outside creditor that obtained a charging order, you simply would refuse to move any of the LLC assets outside of the LLC. And then you would have the protection there.
Now, certain States are charging order only. So that’s what I had mentioned: Wyoming, Nevada, Delaware. Other States are not charging order only. So the majority of States are not charging order only States. But it’s important to understand that you are free to form your LLC in any one of the 50 States. Um, and, and also the District of Columbia. You can pick your jurisdiction in terms of forming the LLC, even if your property is located in one state.
So for example, I might have property physically located in California. I can still form a Wyoming LLC to hold title to that, uh, to that property. If you were to do that, though, there is some question, do we use a state, you know, do the laws of the state where the property is located apply, or do the laws of the state where the LLC was formed, apply? It’s a gray area, but it gives you at least a fighting chance. And it’s usually not that much more expensive to form an LLC in a charging order only state rather than your home state if it’s not a charging order only state. And it’s worth that, that extra small, extra expense in order to give you a shot at protection against outside creditors – give you two-way protection rather than just one-way protection.
Now, one thing that’s very important is that if you do form, an LLC in a charging order only state and the property is actually located in a non-charging order only state. So let’s say the property is located in California, but you’re forming it in Wyoming. The way to really give yourself creditor protection is to make it a multi member LLC. And that means a multi owner, LLC. That means you want to have more than one owner. A married couple in a community property state is pretty much – like California – is considered one owner. So you want to have somebody else on there. They can be a small percentage, maybe 10%. Um, but you want to have someone else out there. And the question is why, you know, why do you have to bring in another owner?
Well, the whole idea behind this charging order remedy is it goes back to partnership law. And historically the idea was that let’s say you had multiple, uh, co investors in a property in a business property. And then one of those investors, one of those business partners, uh, did something personally had nothing to do with a business at all, had nothing to do with the other business partners. And that one partner got into trouble and got in a car accident and got sued for some personal reason. And the question is, is it fair to allow that partner’s creditors to come and interfere with the operation of the partnership? And so the whole idea behind this charging order remedy was to protect the innocent partners of the business. And if it’s not a multi-member LLC, then you don’t have any innocent owners and the protection might not be there.
Now, some States, um, by statute have said, even if it’s a single member, LLC, there still will be asset protection. But if you have property in a state, that’s not a charging order only state, uh, it’s best practice to make sure it’s a multi-member LLC to make sure that there’s a protection there.
So I hope this gave, gave you a general overview of how a limited liability company can provide you asset protection, uh, both from inside creditors and in certain cases from outside creditors as well. Uh, hopefully you can see that there are a lot of moving parts there. This is just a general scratching of the surface. There are lots of other things it’s very critical that you form the LLC correctly, that you title everything correctly, that you draft the operating agreement correctly. And there could be some traps for the unwary. For example, although there are a lot of good asset protection reasons to put rental property in an LLC. There could be other pitfalls. In California, we have to have special considerations with Prop. 13 and trying to preserve the Prop 13 property tax base for the next generation. An LLC could interfere with that unless the LLC is structured properly. So it’s very important that you seek the advice of a competent attorney. Uh, but hopefully this video gave you some basic ideas about how an LLC can provide you with a pretty strong degree asset protection.
I hope you enjoyed watching my video. As I mentioned at the beginning, this is not intended to be a substitute for proper legal counsel. Before acting on any of the information contained in this video, you should consult a competent attorney who is licensed to practice law in your community. Thank you.