This is the time of the year when many island condominiums, townhouses and homes are rented to third parties. The rental income helps carry the costs associated with these residences, and in some cases provides a decent income stream to the rental unit owners.

Many owners, however, fail to consider how to limit their liability exposure if a renter gets injured during the course of their stay. The first course of defense is, of course, the homeowner’s liability policy covering the premises. It’s always a good idea to advise your casualty insurance carrier that you are renting the property as opposing to using it solely for personal and family use.

Many carriers require a separate policy or a rider to the policy for rented units. If the insurance company discovers that the injured party was a renter, and if the right type of insurance policy doesn’t cover the unit, then the owner of the unit may find himself having to personally pay for the defense of the lawsuit as well as be on the hook financially for any judgment obtained.

Even in cases where the proper insurance covers the unit, occasionally the liability insurance coverage isn’t enough to shield the owner from liability occurring from catastrophic injuries or death. In such event, it is a good idea to have an umbrella policy in addition to the insurance policy itself. Again, when purchasing umbrella coverage one should ensure that the carrier is aware that third parties rent the premises.

An often overlooked detail is the ownership of the rental unit. Many mistakenly believe that if their Revocable Living Trust owns the rental unit then they are shielded from personal liability. This is not true. Most revocable living trusts allow the grantor of the trust to revoke, amend or withdraw their assets from the trust at any time. Therefore, the law treats the grantor of the trust as the owner of the trust property. If there is a lawsuit for negligence associated with the property, then the judgment creditor may not only obtain a lien against the equity of the property itself, but may also seek retribution from the property owner’s other assets, which might include stocks, bonds, mutual funds and other liquid assets.

One strategy commonly used to limit the liability exposure is to place the property into a corporation, limited partnership or limited liability company. Each form of entity ownership offers its own unique set of advantages and disadvantages. In Florida, for example, limited partnerships offer certain types of statutory protections while limited liability companies offer similar common law protections.

Income and estate tax considerations must also be considered when transferring rental properties into an entity. Corporations, even S Corporations often have adverse income tax consequence upon the distribution from the corporation back to the corporate owner. LLCs and limited partnerships are often preferred vehicles from an income tax perspective.

Many of the entity choices also offer estate planning benefits. If one dies while owning a property outright or in a revocable living trust, then the full value of the property is generally included in one’s estate for federal estate tax purposes. Same holds true for making a gift of an interest in realty. If instead one holds the property in an entity, then when making gifts or transfers of the entity interests various discounts are usually achieved, lowering the amount of the taxable gift or transfer.

The language found within corporate shareholder agreements, LLC operating agreements or limited partnership agreements are very important when seeking to limit liability or limit taxes. If you own the property with others, then it is even that much more important to make sure that appropriate buy/sell provisions are drafted within the document.

If you own rental properties in your name individually, within a revocable trust or with others, it is probably a good idea to review these issues with competent counsel.

©2008 Craig R. Hersch