November 1993
Vol 16 No 2
It's odd how people approach their work and/or their business activities in a rational manner, yet fail to the take the same approach with the assets they accumulate from their earnings and investments. Nobody succeeds for long in business without knowing what the opposition is doing, gauging the markets, tailoring product and services to meet the needs of both present and future customers, avoiding unnecessary expense and loss. Yet, for some reason, that same prudent person who can amass a fortune through business, can't seem to protect it personally. Maybe we can shed some light on this.
Let's assume that you've got $100,000 in liquid savings. You can add or subtract as many of the zeroes as you feel comfortable with, but for now, we'll presume that $100,000 would provide sufficient financial security to meet all your future needs if nurtured properly. Now, the question is, what could happen to it? Perhaps by looking at some of the threats, we can devise an approach which will protect it.
Let's divide the threats up into several categories. The first division would logically be INTERNAL and EXTERNAL threats. In the INTERNAL category we might include break up of the family, serious illness, death and disappearance, extravagant life style and poor habits of thrift and prudence, investment inexperience and gullibility and unbusiness like approach to management of personal funds. In the EXTERNAL category we'd include theft, taxation, extortion, financial liability, regulatory fines and penalties such as might be imposed by EPA, OSHA, SEC, etc.; legal liability through breach of contract or default on notes and leases, personal judgments imposed by courts of law because of tort liability, economic and political system breakdown. That's quite a handful. Let's see what we might do to cut the problem down to manageable size:
FIRST COMES HEALTH . . .
The Arabs have a saying. Health is 1. Family is 0. Knowledge is 0. Wealth is 0. Security is 0. Together they add up to 10,000. But without health, all that's left are worth 0. Anyone with health and disability problems will tell you that the Arabs have figured it out pretty well. Health in America in this century boils down to choices we make in nutrition, rest, exercise and preventative medicine in contrast to overeating, chemical abuse, stress, indolence, early detection of disease and smoking. Aside from accidental injury, birth defects, and/or contraction of disease (which includes aging), 95% of all the afflicted can trace their problems to simply not taking care of themselves. If you want to see wealth disappear, spend a little time in a hospital under treatment.
Jimmy Napier once said that death is just nature's way of telling you that you have to start slowing down a little. It can also have a devastating effect on the estate you leave behind that you haven't planned for adequately. Suppose you disappeared off a cruise ship today, what kind of mess would your survivors confront? Debt owed or owing? Unfulfilled contracts? Tax liabilities that would require liquidation of the most choice properties, leaving only the dregs to support your heirs? Would there be enough insurance? Does anyone know where the policies are? Is there any cash stashed in locations that you haven't told someone about? Who could sign a check besides yourself in case it were needed? How is property titled? Is there any record of what or where it is? Locations of safe deposit boxes? Important records?
If you haven't contemplated the problems your untimely death or disappearance would create, it's time to get your affairs in order. This isn't something you should do when you reach age 90. You could have a stroke, get hit with a car, be in a plane crash, or fall out of a boat at any age. Not planning for your succession would rob your family of all the fruits of your labor and their sacrifices over the years. This is an area in which Trusts are extremely valuable, both in the area of estate planning as well as operating entities that never die and which could carry on through successor trustees.
Serious illness and death can place intolerable strains on a family when financial matters are also in disarray. So can the press of business and accumulation of wealth. Divorce has ruined more financial plans that you can count. Think for just an instant of all the people whom you know personally who have been completely wiped out as a result of a divorce. Two cheaply as one, but when they break up, that means that each of them are going to be on half rations. Keeping families together is beyond the scope of this letter, but you can do something to prevent the disastrous effects of divorce.
Preventative measures might include separating the estate into his and hers at the outset. Sure this is hazardous if divorce is on the horizon, but with each spouse owning his and her own property, there's little profit on either side for breaking up a marriage. Furthermore, there's a lot less marital stress when the person making the bad financial decision is only losing his or her money. Property inside a trust is exempt from any spousal rights, and, from a practical point of view, it's unlikely that both spouses would ever co-sign for each other or be subjected to a judgment that would deprive them both of their estates. With separate estates, there will always be enough 'seed corn' around for a fresh start. It's sure worked for me.
CAPITAL MOUNTAIN OFTEN HAS SLIPPERY SLOPES . . .
Conceptualize wealth as an accumulation of capital all piled up into a mountain range which keeps out the cold of winter, the heat of summer and the barbarian hoards during harvest season. But climbing that mountain into the fertile valley on the other side is tricky. I climbed it 2 times and slipped back before finally figuring out that every step of the way puts one's position into jeopardy. The higher you get, the more conservative you should become. As in any mountain climbing experience, you reach a point at which you're risking a 5000 foot fall just to get one foot higher up the mountain. Failure to realize that has cost many an estate builder to go broke just when the pinnacle of success was beckoning a mere hand or foot hold higher up.
Someone once said, 'dying is easy, comedy is hard.' To this I'll add, investing is almost impossible without Herculean preparation. It's common to take 5 steps forward and fall back 4. You're still moving forward, but very slowly. Most of us realize surplus earning from something that we do very well, then we invest the money into something we know very little about. And for some reason, we resist studying investments even though we might be making decisions with sums of money that represent years and years of laborious savings. It seems axiomatic that we owe our investments the same kind of energy and intellectual probing as we demonstrated in accumulating the funds we've invested. Study what, how, where, when, why and with whom to invest is something we can all do – and something we must do if we're going to keep what we've made.
It goes without saying that the fundamental process of accumulation requires a lot of discipline. We have to internalize the simple fact that the day we stop producing income, it stops. Our lifestyle stops at the same time unless we've established some sort of nest egg which will produce the after-tax income required to support it. This could be in the form of a pension guaranteed by a bankrupt government or corporation. But, those who read this letter rarely have that much confidence in either form of security. No, you're going to have to tough it out, sacrificing a little today and by-passing all those goodies and luxury items so you won't live lives of quiet deprivation tomorrow. It all starts with an iron-clad budget that you and your family can stick to for years. Or you'd better count on winning the lottery.
EXTERNAL THREATS TO YOUR SECURITY ARE EVEN GREATER . . .
Let's break these up into government threats and all others. Take a moment and list all the people whom you know personally who have been innocent victims of the court system because of civil penalties. I'll bet your list isn't very long. We seems to have an irrational fear of law suits against innocent people, but how often do we actually see such a phenomenon? When I say 'innocent people' I'll even include landlords who have been wiped out because a drunk tenant fell down some steps, or because someone was mugged in a building where light bulbs and door locks had been broken by tenants themselves. But even with these bizarre incidents, it doesn't account for the terror that law suits inspire.
The first remedy is insurance. I've been a landlord for 36 years and have yet to be sued by a tenant. But should that happen, I've got insurance to at least enable myself to hire a first rate attorney to defend the suit. A more important weapon in my arsenal of defense is to abstain from activities that are clearly going to be deemed unfair, immoral, fattening or illegal by the courts. When you're wrong, take immediate steps to remedy the matter. When you're right, you can mount an effective defense by holding assets in myriad entities which will create problems for would-be predators who think its going to be easy to extort money simply by threatening a suit.
What might these title holding structures be? I like corporations and trusts to be the first line of defense. Think of them as pawns that can be sacrificed if need be to win a position in a legal chess match. If you reside in a state in which landlords aren't given a fair hearing in court, it's not a bad idea to have the ownership titled in an out of state trust. The beneficial shares of that trust can be held by an out of state corporation as beneficiary. The property itself could be leased to you. Your only asset might be that lease which gives you the right to sub-lease to another person. In many states, this makes you a tenant – and the beneficiary of all landlord/tenant laws – outside the provisions of the laws that apply to landlords. In other states, you can still be considered the owner, but any asset search will turn up nothing, and the suit would stop right there.
The fact that the suit must be conducted across state lines – possibly in a jurisdiction more favorable to landlords and higher costs might be enough to chill the ambitions of both your adversary and his counsel. Even then, the assets can be isolated in separate trusts so that even if the trust lost a major suit, the court would only be able to look to the particular trust and beneficial interest for redress. That takes the fun out of the game. Those who would seize the earnings of a trust have to get a charging order the same as those who'd levy a limited partnership. With no earnings, there's no game. It's important to select a trustee and to form a trust which makes this a viable asset protection strategy. A standard living trust probably isn't good enough.
There's another simple way to hold property so that it's safe from those who use the court system to loot others. Be the lender, not the owner. Think back over the past decade. Haven't the lenders who've held mortgages on viable properties (as contrasted to those failed lenders who loaned money to officer's cronies and families) been the big winners? There are still people out there paying 18% on loans when real estate income and growth has been less than 10% over the same period. That has transferred the equity in the property to the lender.
Suppose you found a property you liked, and had your out of state corporation buy it with funds you loaned it. You'd merely be the lender. By using standard FNMA documents, you'd have an assignment of rents to guarantee payment. This would garner unto you all the cash flow. If there were to be some sort of legal actions, it would be directed to the impecunious corporation whose assets would be mortgaged to the hilt to you. You'd be completely out of the line of fire. But your loan documents could easily contain a clause enabling you to demand payment at will. This too would slow down the minions of the evil Khan who might be tempted to drag the owner into court.
GOVERNMENT POSES THE GREATEST THREAT OF ALL . . .
While it may be difficult to list those whom you know personally who have had their day in court and lost, it's not as hard to list those whom government has victimized in one form or another. Let's talk zoning, impact fees, housing inspectors, property taxes and assessments, condemnations, income taxes, pay roll taxes, sales and use taxes, permits, occupancy licenses, rent controls. We all go to bed at night hoping that the storm troopers from the EPA, OSHA, SEC, IRS, DEA, won't come crashing into our house because of violation of a regulation that we didn't know existed. These are real threats that we must all guard against. But how do we defend ourselves against such powerful forces? The same way as all other weak creatures do. We stay out of sight.
Government swats flies with sledge hammers. Few who mount direct challenges to government live to do much other than to compare financial scars. On the other hand, the landscape is littered with the financial corpses of those who would legally fight government with its unlimited resources. They may have won the war, but lost everything in the fight. It's better to understand as many of the requirements as possible, and to avoid problems with those you don't understand.
The EPA is potentially the greatest threat of all. It's proponents are driven by righteous zeal not confined to the limits of regulations because many of them haven't been written yet. I doubt if a square foot of Florida couldn't be classified as 'wetlands'. Most of Houston is already. And what do you do when spotted owls, snail darters and wood peckers have rights superior to the U.S. Constitution? My new approach is to only buy land that has already received an EPA clearance. That's the same approach I use in other real estate.
Investing in single family houses avoids most of the problems with the EPA, SEC, and OSHA. DEA can be another matter entirely. When a tenant traffics in dope, the innocent landlord could lose property. The recent Buena Vista decision gave innocent landlords some relief, but it took the Supreme Court to do it. The lower federal and state courts wouldn't. Selection of properties and tenants that would not normally be involved with the underbelly of society seems to me the most prudent way to deal with this. Early in America's 'chemical revolution' I sold all my low income properties to avoid this problem. I've never regretted it, even though those who bought them from me have made a lot of money at the expense of management intensity and DEA risks.
That leaves us with the IRS. You can't have a more fascinating or rewarding hobby than study of the Internal Revenue Code. It will pay dividends immediately once you begin to see how things connect. Take a H.R. Block course to learn the documents. Then audit a college course in tax accounting to learn how to find and interpret the rulings. You'll never be the same again. And you'll become sensitive to the ways in which things can be done to avoid tax problems. Clinton's new taxes will create a more or less level playing field for tax preparers. Everyone will have to study the new rules. This is an excellent time to take the plunge. In the 10 weeks or so left in 1993, you may be able to effect dramatic changes in the amount of taxes you'll have to pay.
More importantly, you'll be able to stay clear of trouble by gathering financial information which will support the tax strategies you employ. You'll find that your relationship with tax professionals improves tremendously as you begin to speak their language. And you'll be better prepared in the event that your return is selected for audit. Bear in mind, all an audit does is to compare the way you've arrayed your financial affairs and presented them on your tax return to the regulations written by the IRS to verify that you've done things correctly. Knowing those rules as they apply to you can be a tremendous advantage.
Commerce Clearing House's Master Tax Guide is the same book that your auditor will be trained out of. Each year it's a good idea to buy one. You can order a book by contacting Commerce Clearing House, Inc. at 4025 West Peterson Avenue, Chicago, Illinois 60646. Or you can contact Jim Napier at (904) 638-0005. He buys hundreds of books and sells them at wholesale each year – even at a price below Commerce Clearing House. There's only one catch. You'll have to look at his picture all year as you look up the information that you'll need. I wish you luck in your quest for asset protection and knowledge. There's no such thing as a wasted day when you learn something worthwhile.
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