Are you in the short-term rental market? Do you own
properties that you rent out for a few days or a week or two at a time? Airbnb
and other popular rental websites have made it easier than ever for property
owners to make extra cash renting their properties out on a short-term basis.
But one thing most people don’t think enough about when they are looking to
turn a profit on the short-term rental market is the potential for major liability
exposure if something goes wrong.
“How bad can it be?”, you might ask. Well, how about paying out $11.6 million in damages after your
tenant gets drunk and dives into a body of water you don’t even own?
This is exactly what just happened to Roy and Cindy
Cheatwood, Louisiana residents who were renting out a condo they owned in Gulf
Shores, Alabama on a short-term basis. The condo is located on West Lagoon
Avenue, just a short walk from Little Lagoon.
In 2016, the Cheatwoods rented their condo to tourist Samuel
Steib and a group of his friends. After drinking whiskey and beer for
approximately 8 hours, Steib dove into Little Lagoon head-first, causing a spinal
fracture and resulting in Steib becoming a quadriplegic.
Steib successfully argued that the Cheatwoods were indeed
responsible for his drunkenness, because they apparently knew that Little
Lagoon was shallow and not safe to dive into, but they failed to adequately
warn their short-term tenants of this fact.
Protecting your Assets by Holding Rental Properties in an
LLC
The Cheatwoods have just learned a very expensive lesson.
It is not known what type of ownership structure they had with regards to their
condo in Gulf Shores, but if they are like most people who are in the
short-term rental market (or even the majority of those who own rental
properties with long-term leases), the condo was probably owned by them
personally.
This means the Cheatwoods are now on the hook for $11.6
million – minus the limits of their liability insurance, which is typically no
more than $500,000, plus maybe an extra million or two if they had an umbrella
insurance policy. This could very well mean financial insolvency – unless they
had the foresight to set up a limited liability company (LLC) in which to hold
their property.
An LLC is an inexpensive vehicle that can limit your
personal liability exposure if you own rental properties. If your rental
property is owned by an LLC, then only the assets within that LLC are at risk
if someone files a lawsuit for something that goes wrong on your property.
So, if the Cheatwoods had their condo and no other assets
in an LLC, then Mr. Steib’s damages would be limited to the net value of the
condo (total market value minus any loans on the property). Which means in this
case, having an LLC would have likely saved the Cheatwoods somewhere in the
neighborhood of $11 million.
Advantages of Creating LLCs for Rental Properties
As you can see, the “limited liability” aspect of an LLC
is hugely beneficial to a rental property owner. You never know what kind of
trouble your tenants or their guests will get into, and it is just plain smart
to have this kind of protection in place.
You may think that the Little Lagoon lawsuit is an
extreme example and that something like this will never happen to you, but in
today’s litigious society, how farfetched is it really?
Here is a question – does your rental property have a
balcony? Most condos do, and a lot of them are on the second or third floor or
higher. If this is the case, what happens if your tenants are drinking on the
balcony and someone falls off? Do you think they won’t find a way to blame you
for that?
There are countless other scenarios like this which can
cause major liability exposure. But if you have your rental property inside of
an LLC, you gain the peace of mind that comes from knowing that there is a very
hard limit to what someone can sue you for.
In addition to limited liability exposure, LLCs offer
several other advantages to rental property owners:
- Pass-through Taxation: An LLC has tax
advantages over other types of entities that you might set up to limit the
liability exposure with your rental property. For example, corporations are
taxed directly on their profits, then the owners are taxed again when they
receive income from the business. With LLCs, the company’s income passes
through directly to the individual income tax return of the owner(s), meaning
your tax liability exposure is also a limited.
- Great for Multiple
Owners:
LLCs are a great option for rental properties that have more than one owner, or
“member”. An operating agreement can be created that spells out the rights and
responsibilities of each member, making the property easy to manage and
limiting the liability exposure of each member.
- Relatively Easy and
Affordable to Setup:
Compared to trusts and other business entities, limited liability companies are
easier and less expensive to set up and maintain. There are some areas that
require the assistance of an experienced attorney, particularly when it comes
to transferring the title of the property to the LLC, creating an operating
agreement for the company, and some other complicated issues. But all in all,
LLCs are a very affordable option that can be looked at as “cheap liability
insurance” for your rental property.
- Can Set Up Separate LLCs
for each Property you Own: If you own more than one rental property, it makes good
sense to set up a separate LLC for each property. This way, only the one
property is at risk in each separate LLC. And because limited liability
companies are fairly easy to set up, it is not too much trouble to protect each
of your rental properties with a separate LLC.
Speak with a Seasoned Alabama Business
Attorney
As we have seen from the recent verdict in the Little
Lagoon lawsuit, no rental property owner is safe from the potentially
devastating financial impact of a frivolous lawsuit – if the property is in the
individual owner’s name. By setting up a limited liability company, you can
protect yourself from this danger while continuing to reap the benefits of
earning passive income on your rentals. To ensure that your LLC is set up
correctly, be sure to work with a knowledgeable Alabama business lawyer.
At Davis & Fields, we have two decades of experience
helping clients in Alabama create LLCs and handle all other business legal
matters. We work closely with our clients, putting our extensive experience to
work to develop the most practical, effective, and cost-efficient legal
solutions.
For a personalized consultation with one of our
attorneys, call us today at 251-621-1555. You may also message us through our
online contact form or stop by our Daphne, AL office in person at your
convenience.
