As many of you know, helping you to become a successful real estate investor is not the only goal of my courses. Helping you to protect what you have worked so hard to achieve is just as important! After all, if you don’t protect what you have, you’ll be more likely to lose it one way or another.
Now it may sound a bit counter intuitive, but debt is one of the best ways there is to protect your property from legal judgments. To many of you, I’m sure that debt is a four-letter word. But the fact is that there are several ways that debt can be your best strategy for asset protection.
1. Good debt and bad debt
For example, say you have judgment against you. Your home is held in your name and it’s worth $500,000. Let’s say also that you have a $300,000 mortgage with the bank on the home. How much would you have to pay?
The bank is the first creditor for the mortgage, so that would not apply to a judgment collection. You would have only $200,000 in equity so that would be your exposure in this example. Your mortgage has saved you $300,000!
Now, in that same scenario, say that you had a $200,000 second mortgage held by one of your companies. How much would you be on the hook for then? A big fat zero!
That’s one way debt can actually protect you. The key is to have good debt, not bad debt. For me, good debt is debt that I have with myself. I don’t care how much debt I have with myself, because I never have to pay it off because I’m both the borrower and the lender! You want to have as much good debt as you possibly can.
2. Be aware of your debt levels
Always be sure that you can afford the debt levels you’re taking on. Never put your head in the sand with debt. If you’re borrowing from your house to buy another property, make sure that whatever you’re borrowing the money to buy, can pay for the debt. That includes the interest on the new loan plus the interest on the equity loan from your home.
But that’s not all. The new investment must also pay for the insurance, maintenance and management of the new property. Finally, after all those expenses are covered, there should still be a little bit of money left over. That’s what a positive cash flow property should look like. Anything less and you’re deluding yourself.
3. Be aware of market rates
Be sure that you keep up to date with market rates. Know what they are as they adjust up and down and what you can get on the open market. Believe me banks won’t call you and tell you to refinance your mortgage at a lower rate!
I remember at one time I had two loans with a bank on some rather valuable properties. The interest rates had fallen to where it made sense to get new loans on the properties. I wrote a letter to the bank saying, basically, that if they wanted to keep my business, then they would need to lower the interest rates on my loans.
And you know what? They did just that! One little five-minute letter saved me over $1,800 per month on interest payments! See how it pays to be aware of where interest rates are?
4. Be efficient with your money flow
You should try to have as much of your money sitting against your mortgage as you can. This is important because of the tax advantages that it gives you. It doesn’t matter what the source of the money might be, whether it’s salary or passive income.
Whatever the source of cash, if it’s against a mortgage, you have a very effective offset in your tax rate. This is another form of good debt, whether the mortgage is held by one of your own companies or by a bank. In either case, you want to maximize the tax protection of your cash flow.
5. Create internal debt wherever possible.
Remember the good debt I talked about in Section 1 above? Well, you want as much of that as possible. You want to create debt that you owe to yourself whenever you come into a bit of cash.
Now, this doesn’t mean you can go around just wacking mortgages on everything willy-nilly! You’ve got to have a reason to do it. But it doesn’t matter where the money comes from.
Did you get a $10,000 inheritance from your great aunt Flo? Great! Create some internal debt out of that flow of money. Sell a property? Fantastic! Create internal debt out of that money flow. Be smart about it, but do it. It protects your property from judgments and can also reduce taxes.
6. Maintain good records
Accurate record keeping is a very important strategy that you must follow at all times. I know this isn’t particularly a glamorous part of real estate investing, but it’s especially crucial when it comes to taxes. Just know this: if you can’t prove it, you can’t claim it.
This means you need to keep all your records easily readable and in good order. If you have receipts that are faded and unreadable, it’s on you to make sure that they can be read. It’s a good idea to photo copy your fresh receipts or scan them into a computer file before they fade. That also means that all receipts and records must be written in English. That’s the law.
And let’s not forget about the legal requirement to hold onto records even after you no longer own a property. How long do you have to keep your records on a rental property? For as long as you own the property, if it’s held in your own name, plus three years. If you own a property in a structure’s name, you have to hold onto your records an additional five years after you’ve sold it. If you’ve owned a property in a structure’s name for 15 years and then sold it, you have to hold those records for 20 years!
7. Hold your debt in the proper structures
This is a case of prevention being much better than cure. For instance, let’ take two similar lawsuits: the first case is where the person being sued holds all his assets in protective trusts, structures and corporations. The second case is where the person being sued holds everything in his own name.
Which case is a lawyer more likely to take on? The one with protective structures in place? Or will he take the one where the person holds everything in his own name?
The lawyer will sue the second person for one very good reason. If he wins the case, it will be very easy to have the judgment paid because none of the assets are protected. But with the first case, even if he wins the case, there is the strong likelihood that he will not be able to collect on the judgment. That’s because the assets and liabilities are protected.
There is much more to the structure strategies, which I’ll talk about at another time, but in the meantime, be smart about your debt and protect what you’ve worked so hard to obtain. You’ll sleep better, too!