March 2001
Vol 24 No 7
To many, “Asset Protection” connotes foreign trusts in tiny tax haven islands, Banana Republic Banks, or arcane political enclaves such as Lichtenstein, Andorra, Gibralter, Campione, etc. To others, “Asset Protection” involves tax and estate planning; and the use of corporations, limited liability companies, and trusts. To yet others, the foundation of “Asset Protection” is concealment of the ownership of their assets and identities behind cleverly constructed facades which act as lightening rods to divert potential threats toward false targets.
These strategies can be very effective when it comes to protecting assets, but they don't necessarily enhance the process of accumulating, Compounding, and preserving assets. People who make a fetish of privacy and asset protection often lose money because they don't exercise prudence in the way they invest, manage, and control their assets. An off-shore bank account does little good if the funds deposited there fail to earn a market yield; or worse, they are spirited away by Some foreign trustee. For most people, the loss of earning power and of principal pose a greater threat to assets than invasion of capital by predators or creditors.
In the past few months, a number of subscribers have reported losses stemming from a variety of causes. These include theft, unauthorized contracts, fraudulent invoices, embezzlement, misrepresentation, lack of due diligence, inadequate documentation, failure to protect cash, lack of tax planning, etc. Hundreds of thousands of dollars have been thus squandered, representing years of personal sacrifice and hard work spent accumulating money that was stolen.
The irony is that these losses could have been avoided if those who suffered losses had let their heads rather than their emotions dictate their management and investment decisions and activities. In one case, “trusted” corporate officers covered up mis-management of the business by reporting non-existent sales and robbing some accounts to make deposits-into others. This could have been discovered from the onset if cash and credit controls had been established. Keeping those who make deposits away from those who make payments, can make it very hard for employees to divert income into their own pockets.
Only long time, loyal employees should have access to check books. The person who receives payments and who makes deposits shouldn't keep the books, or be authorized to sign checks. Only one person should sign checks or have access to credit cards. This same person should not make purchases, generate invoices, or manage inventory. In management terms, this is called “separation of functions”.
In a “Mom and Pop” house rehab or rental business, Mom for example, might be in charge of depositing income from rents or sales based upon written rental agreements and closing statements. Prior to writing checks, Mom should match receipts with outstanding invoices for services, bills of sale for personal property, and closing statements for house purchases. With each deposit or payment, she should make a “journal” entry into some sort of daily record with the date and payment amount, oriented toward the specific supplier or property. In this endeavor, Intuit's computerized “Ouicken” software works quite well. For non-computer types, there are a variety of “one-write” systems such as “Safeguard Systems” that can make mincemeat out of the financial record keeping chore.
Pop might order supplies and materials, contract for services, etc. He should cultivate the practice of doing as much as he can through Standardized faxed order forms, and give these to Mom as a basis for payment of the bills. Checks should be annotated showing the property, transaction, or specific account they were being charged to. Copies of each check and invoice should be made in the event of any future mishap, or audit. At tax-time, these transaction records can be used by their tax preparer to render accurate, audit-proof tax returns.
THE BIGGER THEY ARE, THE HARDER THEY FALL . . .
For most people, buying a single family house can represent the biggest and most important decision of their lifetime. For entrepreneurs who buy and sell, or hold and rent houses, the buy/sell decision becomes much more routine. For those who have accumulated a portfolio of profitable single family rentals, there is a temptation to venture out into other real estate investments. What many of them fail to apprehend is that the single family investment house is a relative no-Drainer when compared to other kinds of real estate investments.
The complexity of real estate can grow geometrically as one goes from single family houses to condominiums to resort properties to multifamily housing to agricultural property to land development to commercial real estate to industrial property. The amount of training, education, and experience the successful investor, speculator, or operator needs to command grows proportionately with the complexity of the investment; yet relatively few investors who move up the real estate scale actually invest time learning the fundamentals of investment in larger properties. They seem to rely almost entirely upon the advice of those who have vested interest in spending their money.
It constantly amazes me that people who study consumer reports and engineering specifications for months trying to decide which riding lawn mower to buy will rush into major purchases of stocks, or of an investment house, with only the sketchiest information. People are even more casual at real estate marketing meetings in which even more expensive properties are exchanged for others without current appraisals or financial details. Many people buy apartment houses without knowing local landlord and tenant ordinances, or even examining leases. The same goes for office condos, warehouses, and retail space. In the world of real estate investment, the sky really can be the limit. And it can fall too.
Land “in the path of progress” is gobbled up and paid for, and money is rounded up from private investors based upon an artist representation of something that could be built on it; without a thought to zoning or permits. Relatively naive unsophisticated people, and licensed professionals alike, rush in heedlessly to share in proclaimed profits in high-yield hypothecated discounted Notes that nobody really understands nor takes the care to document.
The easiest way for the entrepreneur to get into trouble is to jump into income tax strategies that promise to wipe out tax liability through the use of various trusts; supported by obscure references in the tax code that have long since been revoked. I've heard of people who have invested thousands of dollars in schemes, supposedly based upon Common Law, only to wind up losing all of their investment, and then having to pay back taxes, interest, and penalties to boot.
A fiction that surfaces almost every year is that an off-shore trust can legally reduce income taxes for American citizens. In 99% of the cases. this simply is not true. But people entrust their assets to unknown Trustees in sovereign countries with unfamiliar banking and tax laws, then expect to be able to repatriate their money tax-free. It seems the farther away the Trustee, the less people check out their credentials. An attorney from the Isle of Mann who wanted to be my Trustee was insulted when I suggested that I knew less about his credit rating than I knew about my worst tenant. Incidentally, he recently disappeared without a trace.
To paraphrase Warren Buffet: Rule #1 in asset protection is not to lose. Hares who lose money, then rush into even more speculative adventures to recover it, only to lose more, are virtually guaranteed to lose out to the financial tortoises out there. Exercising caution both in your business and in your investment can pay larger dividends than a cavalier attitude toward the way income and expense, and control of cash, are handled. Everybody complains about nit-picking appraisers, bankers, accountants and attorneys who slow down and kill deals, but, in almost every case, had normal documentation, conventional closing procedures, and prudent due diligence practices been employed, nobody would have lost anything.
TARGETS ARE MADE TO SHOOT AT . . .
It's a lot harder to keep assets than to acquire them. An easy way to have your net worth disappear in large chunks is to have a judge and jury take it away from you. I don't think many people who watched the American justice system in action during the Clinton years have very much confidence in it. This is particularly true when a host of sleazy contingent-fee attorneys crowd television channels exhorting viewers to litigate virtually every aspect of human existence.
Despite the fact that many real estate entrepreneurs, bogged down in highly leveraged rentals, live from hand to mouth, landlords are perceived as being rich. They are targets of suits aimed at extorting settlement money as a cheaper solution than going to court. And when property owners elect to duke it out in court, as often as not, they are subjected to the tender mercies of an elected judge who rules against the elite landlord class; many times in violation of written statutes.
Heaven help you if you ever have to defend yourself in an action in which you have taken a politically incorrect stance. Think how comforting it would be to try to prove your innocence in front of a jury that looks like the audience at a Jerry Springer show. In an age of billion-dollar judgments against tobacco, drug, and oil companies, envy-ridden juries think in terms of millions of dollars even in cases that should be thrown out of court; spilled coffee in a MacDonalds comes to mind. We can't protect ourselves from every eventuality, but we can make it a practice to pip potential disputes in the bud before they get out of hand.
The best way to keep out of court is to maintain high ethical business standards, particularly with regard to tenants, clients, and customers. I think “The Customer Is Always Right” isn't a bad way to do business. Bear in mind that, in a world in which charges of illegal discrimination are tossed around at random, by setting up impartial written policies incorporating high standards, you can Screen out malcontents and trouble makers before they become your customers.
The easiest and cheapest way to avoid being shot at is to stop being a target. If people don't perceive that you are a person of substance, they don't envy you, or see you as easy prey. Start by staying out of the limelight. Avoid conspicuous consumption and an ostentatious lifestyle. I know one guy who can't figure out why he has been targeted by local law enforcement types just because he insists on tooling around his town at a high rate of speed in a red Porsche. Not smart! Being spotlighted on the society pages, or giving television interviews about how much money you've made, having multiple properties listed in your name in the tax records, or having a high-profile dispute with the zoning officials aired on the local news program all can bring unwanted attention. So can IRS tax-disputes.
The Internet can be a source of trouble too. When you use your credit card to order things off the Internet, you give millions of strangers access to your most private financial affairs. Anytime your name, date of birth, social security number, drivers license number, and a credit card can be linked, everything else about you from your date of birth, to medical records, to military records, to driving violations, to real estate owned, marital adventures, court records, and income tax returns can be easily obtained by almost anyone. When you order things on-line, or off-line out of mail order catalogs, your name, address, and marketing preferences are sold to other vendors.
Each time you enter your Social Security number onto any form, it eventually winds up in the credit system; available to almost anyone. When you provide your Social Security number at real estate closings, you leave an indelible record of property you own, or have owned. When you file your Social Security number with medical insurance claims or routinely fill it in on medical appointment forms, you open your complete medical history up to anyone who wants to search the databases. What is supposed to be private information quickly becomes public information without your permission. Once financial privacy has been compromised, it can't be restored. It's gone. At this point, real trouble can find you.
IDENTITY THEFT CAN WIPE YOU OUT . . .
If your Social Security number becomes public property, identity theft is right around the corner. One prominent subscriber had his Social Security number illegally used to open a fraudulent bank account. Then the thief proceeded to buy merchandize all over the area, writing dozens of fraudulent checks that were ultimately charged to the victim. Only when the police came to call was he made aware of the theft of his identity. That was the bad news. The worse news was that it took months to finally clean up all of the bad credit and false computer records this generated. The culprit eventually was caught, but the damage had been done.
It's against the law to publish personal information, but who is going to enforce the law when the government is the most blatant offender? The U.S. Postal System is the biggest purveyor of mailing lists in business today. Did you ever wonder why so many personal questions are asked on the census form? That gets packaged as market research. Take a quick look at a lot of government forms, and you'll find obscure notices that the information entered can be made available to a hoard of other government agencies for any use they desire.
The solution to identity theft is to stop giving away important information about yourself. How? Let me hasten to say that putting “wrong” numbers on documents can do as much damage as identity theft if it winds up being someone else's Social Security number. The solution is much, much simpler: All you have to do is to form a Trust, Limited Liability Company, Partnership, or Corporation and get a mailing address that is separate from your personal address. Then start using that name and number on credit cards, bank accounts, applications, telephone numbers, utility accounts, subscriptions, contest entries, catalogs, etc. By using a completely legitimate means to protect your personal and financial privacy, you can take a giant step in your asset protection strategy at minimal cost in terms of both time and money.
Asset protection encompasses preservation and conservation as well. Depending upon your personal circumstances, you may discover that the use of a business entity to conceal your identity also generates new opportunities for business, for tax strategy, for estate planning, and for investment that aren't available for the individual. When you can save taxes, get better financing, raise money for projects, create more prudent leverage, and at the same time protect your assets, it makes little sense not to avail yourself of the opportunities that an artificial entity can create for you.
Here's how a landlord might create a fortress against tenant assault on assets. First, he'd form both a C corporation and a Trust. These two entities in turn would form a Limited Liability Company. The corporation would hold 10% ownership of the LLC, and act as the Managing Member. The corporation would manage both the LLC and its assets: the rentals and provide a full range of tax and fringe benefits to its Officers and employees (you). The Trust could pass 90% of the net income through to the landlord, to be sheltered by real estate write-offs. Highly leveraged property would provide little equity for others to covet.
The LLC, whose only function would be to hold the highly leveraged rental properties, would offer a poor target to legal predators. Both the owners and managers of LLCs would be exempt from liability for judgments against the LLC, so both the Corporation and Trust would be home free. Through the device of organizations formed for a demonstrable business purpose, landlords can achieve almost perfect anonymity, tax advantaged income, iron-clad defense, and operational advantages. Why don't more of them do this? Because they don't know how.
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