Building wealth is meaningless if you don’t protect it. All it takes is one accident and one lawsuit to lose everything if you’re not adequately protected. Everyone’s heard the horror stories. A doctor hits a pedestrian and loses everything because he didn’t have adequate asset protection. Here at Four Peaks Partners, we are avid proponents of investing in productive alternative assets for the creation and accumulation of wealth. However, investment in alternative assets provides an added benefit, asset protection.
Building wealth requires a good offense, active investing with passive income in mind. Protecting that wealth requires a good defense. When looking to protect your assets, first, make it as hard as possible for any creditor to find your assets. The more hurdles they have to overcome, the better it is for you. Second, if they do locate your assets, make it hard for them to seize those assets.
One common strategy to make it hard on creditors to locate your assets is to not hold any assets in your personal name. A simple credit and background check can easily reveal your personal holdings. For investments in real estate, whether directly or through a private placement, an effective asset protection strategy is to hold title in the real estate or private placement interest through a limited liability company (LLC) or limited partnership (LP).
Again, on the theme of shielding your assets, layering is an effective technique. Layering involves investing through multiple business entities set up through a myriad of jurisdictions. So, instead of owning a building directly in your personal name, you would acquire it through an LLC organized in Wyoming that is not owned by you directly but by another LLC organized in Nevada that is owned by you. An investment in a private placement takes care of one of these layers for you.
Now that you’ve made it hard on a creditor to find your assets, you need to make it hard for the creditor to seize those assets if they’re found. Holding your assets through a layer of LLC’s would make it very hard on a creditor to seize them. That’s because in an overwhelming majority of states, the only remedy a creditor has against an LLC that is owned by you personally is to obtain a charging order from the court. The charging order is essentially a right to obtain distributions made from the entity (your LLC) on account of your interest.
Imagine the scenario where you’re invested in a private placement that makes regular income distributions. If you were invested directly in this private placement through your personal name, theoretically, with a charging order a creditor would be able to seize any distributions the private placement company made to you. However, if you owned the private placement interest through an LLC, the distributions to your LLC would not be affected by the charging order. The charging order would only affect the distributions made by this second LLC that is owned by you personally. Because a charging order only puts a lien on your distributions, it can not force your LLC to make distributions. The simple way, therefore, to get a charging order is to never make distributions.
Of course, a charging order would prevent you from receiving direct distributions from your LLC, but nothing prevents you from reinvesting that money into other income producing alternative assets and building wealth through that LLC. You may reach a point where you accumulate such substantial assets that you may decide to pay off the judgment to get rid of it or, in the alternative, never make another distribution to yourself. At the time you set up your LLC, you may consider adding another family member as another member of your LLC in case you’re ever in the situation of dealing with a charging order. In that case, if a charging order ever comes into the picture, the LLC can always make distributions to your spouse or child.
In conclusion, alternative investments in income producing real estate, whether invested in directly or through a private placement, if done correctly will provide a layer of asset protection and make it harder on your creditors to find and seize your assets while generating income to grow your wealth.