By Jacob Stein, Aliant USA. Short-term rentals have exploded in popularity during Covid. Many investors see short-term rentals as a way to enter the real estate market or take advantage of the high rental rates. As the post-pandemic travel continues to pick up, short-term rentals continue to be popular, even as real property prices are cooling off.
Rental properties do not benefit from the state’s homestead exemption protection that is afforded to a personal residence. What is the best way to protect a short-term rental?
If the property is being purchased for cash, then we recommend setting up a limited liability company (an “LLC”) in the state where the property is located. For example, if the new rental will be located in Texas, form a Texas LLC. There is no reason to establish the LLC in states like Wyoming or Nevada (which have great LLC laws). Real property will always be governed by local law, and there is no added value to an out-of-state LLC.
Once the LLC is established and the new property is acquired by the LLC, it is important to set up a bank account for the LLC, collect and deposit rents to the LLC’s bank account, and pay all property-related expenses from the LLC’s bank account. This will help ensure that a future plaintiff will have a hard time piercing the corporate veil of the LLC.
If you are borrowing to acquire the property, whether you can title it straight into the LLC will depend on the lender. You likely will not be able to take title in the LLC if you are getting an owner-occupied loan but should be able to title straight to the LLC if you are getting a commercial loan. Speak to your lender about what they will allow. If the lender will not allow you to take title in the LLC, then the only other viable option is to transfer title of the property after it is acquired.
If you transfer title following the acquisition to an LLC and the lender catches the transfer, they make call the note and you will have to pay off the mortgage (or refinance). The alternative is to transfer title to an irrevocable trust, but that has its own complexities and is not always suitable for income producing real estate.
Another way to protect rental real estate is with an equity strip – essentially by creating an additional encumbrance on the property, to reduce the equity that would be available to a plaintiff in the event of a lawsuit.
We also strongly urge all our clients to carry both an umbrella policy, and a policy specifically designed to cover rental real estate.