Many real estate investors and landlords often ask whether they should use an umbrella insurance policy or an LLC to protect them from liabilities that may arise on their rental property. An LLC protects the owner of the LLC from liabilities that arise on any property in the LLC and prevents a plaintiff from being able to go after the LLC owner personally. As a result, we often say that an LLC protects a business owner’s personal assets from the risks and liabilities of the LLC business. An umbrella policy is coverage above and beyond the typical property insurance but it only adds additional coverage to insurance the property owner already has in place.
There are many issues and factors to consider in making this decision and there is no one-sized fits all recommendation. In many instances we recommend that you have both an LLC and an umbrella policy and in other instances we may recommend just an LLC or just an umbrella policy. The first factor to consider is the cost. The cost of an LLC in our office is $800 and on average you can expect about $200 in fees a year to keep that LLC active with the State (about $900 annually in California, each state is different). As a result, the major cost of an LLC is in the first year but you can plan on having about $200 in fees each year to keep your LLC active. If you have a partnership LLC then you also have the cost of a LLC partnership tax return but the LLC also provides a significant amount of partnership advantages and protections and we would almost always recommend an LLC for property owned between two or more parties.
An umbrella policy on the other hand is typically paid for monthly and there isn’t an un-front cost. Let’s say you are able to get a $1M umbrella policy at a cost of $50 a month. That would run you about $600 a year. Insurance policies have benefits which include attorneys whom the insurance company will appoint and pay to defend you (and protect themselves from having to pay) but also contain certain exclusions to coverage that may leave you with no coverage for the liability you incur.
One very common misunderstanding about umbrella policies is that they ONLY provide additional insurance coverage on top of insurance coverage you already have. So, for example, let’s say you have a property insurance policy with landlord liability protection of $100,000 and an accident occurs on the property that is covered by the policy. If that liability is covered by existing insurance and once that insurance has been exceeded, then the umbrella insurance provides coverage. Umbrella insurance does not, however, provide coverage in areas where you don’t already have coverage. This is a major limitation to and misunderstanding about umbrella insurance. I’ve talked to a few clients over the years who’ve needed to make claims on their umbrella insurance policy and who were surprised to find out and learn that the umbrella insurance didn’t cover any new liabilities or gaps in their existing insurance. As a result, just make sure you understand what the umbrella insurance actually covers.
An additional factor to consider is the type of property you own. If you own a multi-unit property or commercial property we would recommend having both an LLC and an umbrella policy because you have more liability exposure when you have more tenants. On the other hand, if you have a single family rental in an otherwise good neighborhood where you feel less likely to be sued then we may only recommend an LLC or an umbrella policy on its own. Bottom line, consider both an LLC and an umbrella policy in your analysis and get quotes and advice upon which to make an informed decision so that you are protecting your assets in the most efficient and effective way as possible.
And finally, consider the equity that is in the property and your overall net worth. The more equity you have in the property and the more personal assets you have in general then the more reason to have both an LLC and an umbrella policy.