Risk Mitigation – LLC or CLUP

Not that I expect you to know these letters right away, but bear with me.

There’s a common question that comes up with rental properties: have you formed an LLC? An LLC is a limited liability company. This is a business mechanism in which you create an official business for your properties, thereby separating them from your personal finances.

That’s the positive to an LLC – an LLC separates the rental properties from your personal finances. This protects your personal finances in the event of a tenant suing you through one of your properties. However, for this protection to really work for you if you have multiple properties, each property would need to be within its own LLC. For example, if you put 12 properties in an LLC, then yes, they’re separated from your personal finances, but they’re not separated from each other. Meaning, if someone sues you, they can go after your entire portfolio.

Mr. ODA and I have discussed grouping a few houses in different LLCs, but we don’t see the benefit of the costs that go along with it. There are fees to form the LLC, put properties into the LLC, and then an annual fee ($50 in Virginia). We have an LLC for the two properties we have with a partner, but we went a different way for the properties that we own ourselves. We pay $250 annually for a Commercial Liability Umbrella Policy (CLUP).

CLUP

A Commercial Liability Umbrella Policy (CLUP) extends the limits of your primary liability insurance policies. Our CLUP is through State Farm, but our individual policies are not necessarily through State Farm. There are many nuances to how it works; for instance, you cannot have a CLUP on top of commercial liability insurance. We have individual personal insurance policies on all our houses, required to cover $500k, so we can have the CLUP extend those coverages. Each property is listed in the CLUP, even the ones we have with a partner because our ownership had to be at least 50% for it to be covered (which it is).

While the cost will vary based on each scenario and coverage, we pay $250 annually for a $2 million policy. Every 3 years, we’re expected to weigh in on our policy, which includes sending individual homeowners insurance policy documents, each policy’s 3 year loss report, and current pictures of the front and back of each house to our agent. We’ve only had one claim on a property, and that was a car accident that took out our air conditioner in House 1.

CREATING A PARTNERSHIP

We do have an LLC that has two houses in it, but that’s because we own them with a partner.

There’s a cap of 10 mortgages that an individual (or a couple, in our case) can have. When we reached that threshold, we asked our friend and Realtor about other houses we were interested in. Our Realtor purchased two houses as an individual, and then we put them in an LLC to give us ownership. After the first house purchase, we had our real estate attorney set up an LLC. Then after the second house closed, we just had to add that house to the same LLC.

When our partner went under contract on the first house, we created an agreement with him. We owed him half of the down payment and closing costs to be 50% partners on the property. At the time, we didn’t have the cash liquid, and he agreed to allow us to pay him monthly, with interest. So he paid the funds-to-close, and we structured an amortization schedule at the market rate to pay him back. It only took us two months to pay him the balance based on our cash flow, which equated to about $44 in interest for him.

I now manage most of the maintenance, collect all of the rent, pay all of the bills except the mortgage payments that our partner has on automatic billing, and pay him out his 50% share each month.

SETTING UP AN LLC

To establish the LLC, we paid our real estate attorney $393 (split 50/50 with our partner). We answered a few questions, and then we met in their office to sign the paperwork during a half hour meeting. The attorney handled filing all the paperwork with the state and were set up as the “Registered Agent.” A Registered Agent is an individual or business entity that accepts tax and legal documents on behalf of your business.

A year after the LLC was established, I received a bill from the attorney’s office. The bill was for $100 – comprised of $50 for the LLC fee from the state and $50 for the attorney processing the payment. If you’ve read more than one of the posts in this blog, you’ll know that wasn’t going to fly; we don’t pay extra for things that we can do ourselves. I started researching the purpose of a Registered Agent and who could serve as such a person, and I found out it’s not required to be an attorney.

I outlined my proposal to our business partner, and he agreed that we didn’t need to have the Registered Agent as the attorney. He would prefer his other LLCs be managed through them so nothing gets missed, but since I keep a pretty well organized business, I have mechanisms in place that will trigger a reminder of payment if I don’t receive the bill in the mail. We paid the $50 processing fee that year, and then I filed a change with the State Corporation Commission to eliminate the middle man.

LLC AFFECTS

One of the concerns with putting a new mortgage into an LLC was that the bank could “call” the mortgage through the “due on sale” clause. A due-on-sale clause is a provision in a loan that enables lenders to demand that the remaining balance of a mortgage be paid in full if the property is sold or transferred. Transferring a mortgage to the LLC risks triggering the “due on sale” clause, although there were historically very few times a lender would call the mortgage due to an LLC transfer.

Another weird nuance to owning a property in an LLC is that homeowners insurance companies charge more for the same house, with the same human clients, simply because its ownership is placed in an LLC compared to in personal names. For example, after we transferred one of our properties to LLC ownership, the same company increased our annual rate from $484 to $874. We have not been able to figure this one out. Presumably, the biggest source of risk to an insurer is the fact that the people living in the house are not the owners, although when we don’t have a house in an LLC, the insurance company still knows that it’s used as a rental. If there’s anyone out there that can help us understand this behind the scenes insurance nuance, please drop the info in the comments. We were able to find an insurance company with a reasonable price, but it’s still an odd nuance.


For our risk tolerance, we’ve decided that a CLUP is enough coverage in the event of a catastrophe ($500k in regular insurance plus $2M in umbrella). We haven’t established any other LLCs because the cost of establishing individual LLCs is more than we want to take on. However, we did use an LLC where we needed to establish a joint property ownership and be able to legitimately claim expenses for tax purposes. We have two houses, both of which are with the same partner, in one LLC.

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