Real estate is a very common investment among doctors. However, very few doctors have implemented the proper legal structures to get the most out of this investment. As a result, doctors expose themselves to unnecessary lawsuit risks and pay far too much in unnecessary taxes on their real estate investments. The purpose of this article is to show you how to own real estate so that you may be able to protect yourself from real estate-related lawsuits.. Perhaps most importantly, the proper structure could more than pay for itself through the tax savings you may realize.
The types of real estate we are referring to include rental residential or commercial properties, the practice building, or even raw land. The merits of real estate as an asset class are beyond the scope of this article, but the structure to most efficiently benefit from all of these holdings is universal.
As all doctors learned in medical school, "first, do no harm." The same concept can be applied to real estate investing. The last thing you want to do is invest in an asset that generates a lawsuit that threatens all of your other wealth. Each year, millions of lawsuits are filed against the owners of real estate throughout the U.S. They are brought by lenders, tenants, guests, lessees and even trespassers. Let's look at an example of a real estate lawsuit risk:
Rob the Real Estate Owner is VictimizedWhat Could Rob Have Done Differently?
Rob owns a number of apartment buildings. He owns some in his own name and some in his wife's name. The total value of the real estate is $4,000,000 and there is about $2,000,000 of debt on the properties. The rental income more than covers the debt service and Rob and his wife make a nice little profit every month. Rob also has a beautiful home worth approximately $1,500,000 with a small mortgage of about $500,000.
After an unfortunate event at one of the properties, Rob was named in the lawsuit. Though Rob wasn't even on the property at the time of the event, Rob still ultimately lost a judgment for $3,000,000. His liability insurance covered $1,000,000 of the loss, but he had to come up with $2,000,000 himself.
This left Rob with a dilemma. Sell all of his real estate properties as part of a fire sale and mortgage his house for the remainder of the settlement or sell his house and further mortgage his real estate at relatively unattractive loan rates. In either case, Rob was very unhappy about the consequences as both options result in a loss of the equity he had built over the last 20 years. In the end, Rob lost his rental properties and his home. Though he didn't lose his ability to spot a good real estate opportunity, Rob was very uncomfortable going back into real estate after this terrible experience.
If Rob had come to an asset protection specialist, he could have done a few things to protect himself. We will show you a few options here that may be helpful.
Separate Properties into LLCs
A limited liability company (LLC) is a legal entity that affords both inside-out and outside-in protection. In other words, if you had one LLC for each piece of property, a lawsuit arising from one property could only threaten the equity in the property inside that LLC. The judgment would not extend to the assets in other LLCs. Further, if Rob had been sued personally for an accident, for malpractice (if he were a doctor) or for any other personal claim, the LLC would provide a high level of protection from that lawsuit even though Rob and his family own all the shares of the LLC. This is a very popular strategy for real estate owners in the U.S. How LLCs protect wealth is a more detailed discussion in Lesson 6 of our book, For Doctors Only: A Guide to Working Less and Building More. If you want to learn more about LLCs, you can order a free copy (regularly $75, pay only $9 S&H) by calling 877-656-4362 or emailing David Mandell at Mandell@ojmgroup.com.
Separate LLCs with Management Company
To take the above strategy to the next level, many savvy real estate owners use a management company to manage all of the various LLCs that own properties. This technique can provide significant tax and retirement advantages, as the management company can be structured as a different type of tax entity from the LLCs. This allows the owner to get the "best of all worlds" in terms of the taxation of the entities involved. One benefit the management company can provide the doctor investor is to sponsor non-qualified and hybrid retirement plans. These plans can be layered on top of existing retirement plans at the practice level, do not require contributions for employees, can reduce the taxes on real estate generated income, and can ultimately increase retirement income for the owners. The immediate tax benefits could range from $10,000 to $90,000 per year.
Captive Insurance Company (CIC)
A very successful real estate developer or owner could create a captive insurance company to self-insure the properties from various risks. This strategy allows the business to ultimately create a multi-million dollar tax-efficient reserve fund to cover future losses. The same CIC can be used to protect the medical practice from various risks of employee lawsuits, HIPAA and Medicare audits, and other significant risks. One very important fact about the CIC is that its reserves are protected from all creditors, real estate, patients, employees and personal suits. For very successful medical practices or real estate investors, the annual tax reductions from the proper use of a CIC could be as high as $500,000. These savings could become very valuable if tax rates increase and reimbursements continue to be cut. If your total income (from practice and investments) exceeds $1,000,000, you could benefit substantially from the implementation of a CIC. Please contact the authors for a free consultation to see if this makes sense for you.
If you now own significant real estate, or plan to in the future, you will want to maximize the protection of your valuable personal and practice assets (not just the real estate) and minimize unnecessary tax liabilities. This short article is taken from the information in For Doctors Only: A Guide to Working Less and Building More and from David Mandell's ongoing webinar series. For a copy of the book or to be invited to one of his free webinars to help you better understand this and other strategies, please contact the author at firstname.lastname@example.org.
The authors welcome your questions. You can contact them at (877) 656-4362 or email them at Mandell@ojmgroup.com.
SPECIAL OFFER: For a free copy (pay only $5 S&H) of For Doctors Only: A Guide to Working Less and Building More, please call (877) 656-4362.
David Mandell, JD, MBA is an attorney, author of five books for doctors, and principal of the financial consulting firm OJM Group, where Carole Foos, CPA works as a tax consultant. They can be reached at Mandell@ojmgroup.com or 877-656-4362.