Asset Protection …Strategies for Protecting Your Home In Case of Judgment Against You
—Susie S. Brousseau, CLU, ChFC, CFP®
Along with earning power and retirement accounts, the home is often the family’s most valuable asset. Beyond its financial worth, the home often has significant emotional value. Many clients who engage in asset-protection planning often begin with the question: “How can I protect my home?”
There are a number of strategies for protecting the home, each with pros and cons. State homestead laws, tenancy by the entirety (TBE), limited liability companies (LLCs), family limited partnerships (FLPs), and the debt shield are some of the most important strategies. Let’s look at them…
State Homestead Law
Every U.S. state has some type of homestead protection law. In most states, such as New Jersey, New York, California and Arizona, the level of protection is very low when compared with actual market value of the real estate (New Jersey $0, New York $100,000, California $50 to $100,000 and Arizona $150,000). On average, state homestead law protection ranges between about $30,000 and $50,000 of equity—much less than the typical home value of the affluent.
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Tenancy by the Entirety
Tenancy by the entirety, a form of joint ownership available in a number of states, is a viable option for clients of those states, which include Alaska, Arkansas, Delaware, Florida, Hawaii, Illinois, Indiana, Kentucky, Maryland, Massachusetts, Michigan, Mississippi, Missouri, New Jersey, New York, North Carolina, Oklahoma, Oregon, Pennsylvania, Rhode Island, Tennessee, Vermont, Virginia, Wyoming, and the District of Columbia. In these states, the TBE homestead protection on the sliding scale falls between +1 and +3, depending on the state and its court interpretations. (See our article on the sliding scale of asset protection.)
Inherent in Tenancy by the Entirety, are a number of risks including the following:
- Joint risk. Tenancy by the entirety provides no shield against lawsuits that potentially arise from jointly owned real estate.
- Divorce risk. If you rely on TBE for protection and you get divorced before or during the lawsuit, you lose all protections from TBE.
- Liability risk. If you rely on TBE for protection and one spouse dies before or during the lawsuit, you lose all protections from TBE.
- Death risk. Tenancy by the entirety is a less effective ownership form for estate-planning purposes because, at the death of the first spouse, the entire value of the home will automatically be entered into the surviving spouse’s taxable estate.
For these reasons, TBE alone is generally not sufficient protection. Savvy investors generally combine TBE with the debt shield technique.
Limited Liability Companies and Family Limited Partnerships
Limited liability companies and limited family partnerships are two tools that can protect a primary residence. In fact, many advisers regularly recommend these techniques to their clients for this very purpose. The drawbacks of these methods are perfect examples of why multidisciplinary planning is necessary for the successful business person. Let’s look at some of the problems with conducting asset-protection planning in a vacuum with respect to the home.
Drawbacks of Limited Liability Companies and Family Limited Partnerships
For Protection of the Home
When it comes to the primary residence, LLCs and LFPs entities are not sensible choices. Unlike other assets, the family home has unique tax attributes—most notably, the deductibility of mortgage interest and the $250,000 per-person ($500,000 per couple) capital-gains tax exemption. By owning the home within an LLC or a FLP, both of these tax benefits may be lost, unless only one spouse owns 100% of the interests in the LLC or FLP. However, in a recent case, the court set aside the protections of an LLC when only the debtor owned 100% of the interests in the LLC. For these reasons, we no longer recommend single-owner LLCs and FLPs to protect the family home.
Qualified Personal Residence Trusts
When using a qualified personal residence trust (QPRT), the owner transfers ownership of the home to the QPRT irrevocably. While this is certainly effective for both asset-protection and estate-planning purposes, it comes with a significant cost: You no longer own your home. In fact, when the term of years is up (typically 10 years), you have to pay fair-market value rent to the trust in order to live in the home.
Homes with mortgages present further tax difficulties. For these reasons, while the QPRT is a strong asset-protection tool, we typically do not advise using it for our younger clients whose main concern is asset protection as opposed to estate planning. Nonetheless, if it can be implemented correctly, a QPRT receives a rating of +4 or +5 on the sliding scale of protection.
The Unlikely Solution Most Advisers Cannot Mention
Oddly enough, the best way to protect a home is probably the same way we all started owning our homes—with someone else’s money. By not having any, or by having very little, equity in your home, the bank owns the home. A creditor has very little to gain from trying to attack the home when the owner retains little equity in it—especially when that small amount of equity is partially or completely protected through homestead exemptions.
We can’t go back in time and stop paying down our mortgages. Instead we have a way to address this issue in the present. Unfortunately, most advisers can’t even tell you how to do this. It is the debt shield.
The Debt Shield
The debt shield can be the most effective way to protect the equity of the home. Essentially, using a debt shield means getting a loan against most of the equity in your home. For many clients, this is counter-intuitive; they want to pay down the mortgage as quickly as possible. While this may have an emotional appeal, for asset-protection purposes, it is a bad strategy.
We have designed a compelling debt-shield program. The bank loans the client a maximum amount of the value of the home and then files a mortgage—first, second, or even a third mortgage—in order to consume any remaining equity. The home should be completely protected because most claimants do not want a home with no equity in it.
If you reside in state that does not provide unlimited homestead protection, you must make it a priority to work with your team to protect your home. If you don’t protect this property, there is no need to bother protecting any other assets. The only thing more valuable than your home is your future income.
Susie S. Brousseau CLU, ChFC, CFP®, is Senior Vice President and Wealth Advisor for Blackhawk Capital Partners. She works with a variety individuals to deliver comprehensive financial planning with an emphasis on asset protection and is a nationally recognized speaker on the subject. You can reach her at (480) 505-2011, or email@example.com.
Kevin B. Perlberg, Donald (Trace) W. Tendick, Tom Kueht and Christopher Nei are registered representatives offering securities through United Planners Financial Services, member FINRA, SIPC. Advisory services offered through Blackhawk Capital Partners. Susan Brousseau and Michael Miller offer Advisory Services Only. Blackhawk Capital Partners and United Planners Financial Services are independent companies.
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