Sole Proprietorships Expose Owners to Personal Liability
Updated: Apr 3
Landlords often focus so much on the day-to-day operation of their real estate rental properties that they lose sight of broader organizational concerns, such as entity structure and business formation considerations.
Restructuring your real estate rental business is not exactly the sexiest decision that you can make for your long-term financial success, but it is an important step nonetheless, particularly if it is currently structured as a sole proprietorship.
With effective guidance, planning and execution, you may be able to minimize your tax liabilities, shield yourself from the ramifications of a lawsuit, and avoid probate.
What’s the Problem with Sole Proprietorships?
A sole proprietorship does not exist as a separate and independent legal entity. It simply describes the owner’s relationship to their property or business — as an extension of themselves, and as such, exposed to the same debts and liabilities.
If you own real property in your own name, then you effectively own that property as a “sole proprietorship.”
Perhaps the most fundamental problem with the sole proprietorship structure is that it does not protect you — the owner — from being sued in the event of a lawsuit, whether that lawsuit is based on a personal injury claim or a breach of contract claim.
This may seem rather complicated, but it’s actually rather straightforward. Let’s explore a brief example for clarity.
Suppose that you own a rental property as the sole owner. As the landlord, you are responsible for maintaining the common areas of the property in a reasonably safe condition. Unfortunately, one day, the tenant is injured in a trip-and-fall accident due to a broken stair in the common area. As it turns out, you failed to discover a crack in the stairway that led to it breaking. The injured tenant could potentially bring a lawsuit against you for damages. As you are personally the owner of the rental property (it is in your own name), you are personally liable for the damages.
Now, what can you do to avoid a situation like this? Simple. Hold property as a corporate entity, such as a limited liability company (LLC), or establish a land trust for additional benefits beyond those afforded to an LLC.
By forming a corporation or an LLC, you are effectively creating a separate and independent entity that can be sued as the “landlord” in the event of a lawsuit.
You can work for the entity, and thereby potentially be paid for your services, thus allowing for direct management without the risk of direct liability.
Of course, if you do form a corporate entity to minimize liability exposure, it’s important to understand that there are procedural requirements that must be satisfied in order to maintain the separation of self and entity.
If a court finds that personal and business assets are commingled to a significant degree and that procedural requirements are not carried out (i.e., meetings minutes are not recorded, documentation is not updated, etc.), then they might pierce the corporate veil, thus exposing you to personal liability.
If you’d like to learn more, we encourage you to contact our office to speak with us about your asset protection goals, liability concerns, or questions.
This post is for informational purposes only and does not provide legal advice. Please do not act or refrain from acting based on anything you read on this site. Using this site or communicating with Law Offices of Mark F. Moss, PLLC, through this site does not form an attorney/client relationship.