For most of us, our home is one of our most valuable assets. It truly is our “castle,” but can also be one of our most vulnerable assets. Although we need to protect it at all costs, we face several dilemmas that create significant hurdles to protecting the complete value of our home.
Is an LLC a solution for your primary residence?
First, I’m concerned about the LLC being a simple ‘silver bullet’ solution to protecting a home. An LLC wasn’t designed or built for this purpose. The LLC is obviously perfect for income producing assets, or even a cabin, beach house, farm or 2nd home in a VRBO or Airbnb strategy. But how is a personal residence a business asset, it’s not. If I was a litigation attorney going after a debtor’s home in an LLC I would immediately attack the corporate veil and claim a co-mingling of personal and business assets to say the least. How do you have a ‘separation’ of personal assets and business assets when they’re all in the same LLC? It doesn’t make sense. If someone is selling you an LLC as the perfect solution, have them put it in writing that it will protect them and they’ll be on the hook if it doesn’t- no way…it’s not going to happen. I just think there are better solutions and I don’t even include the LLC in my 6 options to better protect your home.
The moving target of Equity
The second dilemma is that our property is continually increasing in value and the equity is clearly a ‘moving target’. Therefore, we are forced to protect a level of equity that is consistently changing (and hopefully increasing). As such, it is important to realize that any plan to protect your home requires constant updating and revisiting of your strategy on a regular basis.
To pay off or not to pay off my home
Most of us have been taught for years that it is a wise long-term policy to pay down our mortgage (pay off our home) and thus contribute to increasing the equity in our home. Many people view paying off their home as the pinnacle of their lifetime’s work. Regrettably, a creditor or plaintiff will view this as the “golden egg” in his or her efforts to collect a payment from you in a lawsuit. Please be open to protecting your equity in creative ways. I’m not saying that it’s bad to pay off your mortgage and own your home free and clear; however, it is just plain naïve to pay off your home without realizing that you are also seriously exposing yourself to a loss in the event of a lawsuit.
In my opinion, there are 6 legitimate ways to protect our home from a potential lawsuit, and they will vary based on where we live in the country, our marital status and the amount of equity involved.
1. Homestead Exemption
This is a statutory exemption available in most states to protect a certain amount of the value of a person’s home from a creditor or bankruptcy. The amount varies from state to state as do the laws on how to avail oneself of this protection. Essentially if a creditor comes after you in a law suit and forces the sale of your home, they only get the residue after selling costs, the mortgage and your ‘homestead exemption’ amount.
In states like Florida and Texas, citizens enjoy an unlimited homestead exemption and it’s very difficult for creditors to ever get a debtors home. O.J. Simpson exploited this law and since then they modified the law to prevent new residents such as O.J. to pull the same trick. However, it can be a powerful tool for citizens in several States.
This tool is generally available in 44 states and is a law specifically designed to protect a certain amount of equity in a person’s residence from a variety of creditors. Not only do the amounts of the homestead exemption vary from state to state, there are also different rules on how to qualify for and satisfy the particular requirements of the homestead exemption based on the jurisdiction. Approximately, twenty-one states even require that a home owner file appropriate paperwork to qualify for the exemption.
If homeowners want to take advantage of this exemption it is essential that they have a general understanding of their state’s law and consult with their asset protection professional.
2. Tenancy by the Entirety
If your State allows it, you can title your personal residence as “Tenants by the Entirety,” thus protecting your home in a very unique way. In a nutshell, the benefit of this protection is that if one spouse is sued, the property cannot be attached or bifurcated with a lawsuit. For example, if a husband gets into a terrible lawsuit, it’s not fair that the wife loses the house when the lawsuit had nothing to do with her. There are approximately 15-20 States that have this law on the books, including Hawaii (as if you needed another reason to move to the Aloha state).
3. Equity Stripping
Equity stripping is simply the strategy of placing a lien on your home with a mortgage and ‘removing’ the equity in a sense by replacing it with a loan. This makes your home much less attractive to a potential creditor that wants to take your home to satisfy a judgment.
The trick is in the implementation of the loan. Ideally, a traditional HELOC or even 1st Mortgage lien (wherein you utilize the loan proceeds to invest and create additional wealth), is a perfect fit. It’s legitimate and difficult for a creditor to challenge in court and ‘step in front’ of a valid lien holder on the title to your primary residence.
Some home owners will choose to implement a ‘smoke and mirrors’ strategy by creating a shell company, with some degree of secrecy, and liening their own home. The procedure essentially clouds the title and gives the public perception (anyone doing a title or asset search), that your home is liened to the hilt and there isn’t any equity to be had in a lawsuit. This strategy can be successful in dissuading a lawsuit, but in a court battle a judge or plaintiff would slice right through the structure once they discover the scheme that was created.
4. Domestic Asset Protection Company (DAPT)
As a nation, we are becoming more and more comfortable with this type of trust. Over 15 States in the Country have these laws on their books and, under Federal law, they would be generally recognized and upheld in a lawsuit in any state. Typically, you would place any personal residence, cabin, beach house or farm you plan on keeping for life (or at least making very minor moves/changes if necessary) in this type of trusts, and the longer you keep them there the better protection they afford.
5. Put the Title to the home in the “low-risk” Spouse’s Name
In some situations, one spouse may have a “risk issue” with their lifestyle or business and removing their name from title of the home could help protect it. The effectiveness of this strategy varies dramatically from state to state; it’s critical to get a consult with a lawyer that understands the law in your particular state or can at least research it to confirm your current standing.
If one spouse has a more risky occupation or lifestyle, it can be extremely strategic to place assets in the other spouse’s name. In general, the creditors of one spouse cannot reach the “separate” assets of the other spouse. Therefore, asset protection in the context of marriage requires a strategy whereby valuable assets are held as the “separate” property of the spouse with the least exposure to risk. This is where a marital property agreement (i.e. a prenuptial or postnuptial agreement) can be beneficial if the spouses can agree that certain assets will be the separate property of the spouse with less exposure to lawsuits.
For example, in most states, if the husband is a business owner who incurs liabilities, the couple can enter into an agreement that certain valuable assets will be the wife’s separate property, thereby shielding those assets from the husband’s creditors. Obviously, if both spouses agree to be co-debtors on a debt, such as when spouses both sign a mortgage on the family house, then spouses will be jointly liable.
Of course, a word of caution with this planning strategy: Divorce. Thus, think carefully before placing assets in your spouse’s name and the impact of a post-nuptial or separate property agreement. You may protect your assets from a creditor, but throw your assets into harms way with a divorce.
6. Umbrella Insurance
Umbrella insurance is just that. It’s an “umbrella” of insurance that covers a variety of situations that could possibly create a claim. This type of insurance can be personal or business in nature and functions as an “umbrella” over any other type of insurance you may carry. It will cost an average of $300-$500 a year for $1M to $2M of coverage. With that said, don’t assume it will protect you in every instance and you can otherwise throw caution to the wind. As a rule, umbrella insurance isn’t going to cover fraudulent, criminal, reckless or even negligent action.
I’m a huge fan of making sure you have proper insurance coverage. Any attorney that recommends you simply rely on legal structures and not buy insurance is taking a serious risk on your behalf.
In summary, when it comes to protecting our personal residence, every person’s situation is different and also complicated by the state you may live in. Please consider the options above and consult with an attorney at our office for an asset protection plan suited to your needs.
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Mark J. Kohler is a CPA, Attorney, co-host of the Radio Show “Refresh Your Wealth” and author of the new book “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You” and, “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP.