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.