For those who own a home, this is most likely the largest source of net worth, and with the housing market fluctuating as it now is, protecting this asset is critical. There are ways to protect your house from lawsuit risk and this article addresses those vehicles which can be used.
Exceptional Considerations
A residence has certain exceptional legal qualities which are unlike any other type of property. To protect the home from liability threats several crucial factors must be considered.
Continued Enjoyment
A properly drafted asset protection plan will allow for you to continue living in your home.
Homestead Protection
Some states have homestead protection and you should find out if your home is protected by this law. Each state exempts from judgment a certain amount of equity in your home. In New York the total amount that can be protected is $165,550 for a single and $331,100 for joint ownership. In California the amount is $75,000 for a single and $100,000 for joint ownership. Massachusetts allows $500,000. Eight states allow unlimited protection. New Jersey and Pennsylvania don’t have any protection. If the equity in your home is less than the amounts allowed in your state, then no further asset protection is needed. Otherwise, you should consider other avenues.
Plans Which Don’t Work
If you place the residence in a family limited partnership or limited liability company, the IRS has ruled that some or all tax advantages may be lost. Additionally, if a property is placed in an FLP and is reserved for personal use, the protection offered by the FLP might be challenged in a future lawsuit.
Solving the Protection Problem
The key in this scenario is to protect the equity in a home above the homestead amount while retaining the tax benefits and continued right to use and enjoy the house.
The best type of trust for this type of asset protection is the grantor trust. In this instance the trust is not the owner of the property. The trust must be respected for protection purposes but ignored for taxes.
After solving the tax issues the next step is the actual asset protection. It is important to remember that you as the owner cannot maintain the full spectrum of ownership rights. If you do it is likely that a judge would order you to turn over the property to a plaintiff. Therefore, the key is to keep ownership of your home from full and complete to something less. There are a few alternatives to this situation that can protect your home.
Personal Residence Trust
A Personal Residence Trust is a generic term applied to a trust to hold property and employ restrictions which protect it against possible loss. This type of trust is considered to be ignored for tax purposes so that no tax issues are formed and the tax benefits are protected. There are many different designs and strategies which can be used for creating this type of trust, depending upon the specific circumstances of the case.
One alternative is to allow the PRT so that your children or other family members take ownership of the house after a certain number of years. The trust allows you the right to live in the house for a period of 10 to 20 years. Depending on the terms of the trust, there can be excellent tax benefits by freezing the value of the house at its current amount and thereby remove it from your taxable estate. The number of years and other important terms can be modified to meet specific circumstances.
Another alternative is to allow the trust to own the home and lease it back to you for a certain number of years. In the instance you will be paying rent to the trust and the normal tax benefits still apply because the grantor trust rules. At the end of the term of the lease, full ownership returns to you or passed to your children.
In a slightly different version, the PRT could be provided with an opportunity to purchase or a right to exercise some other right over the property within the trust. As an example, the Personal Residence Trust is created which grants the trust an option to purchase the property for the loan amount, any time within the next 15 years. The option agreement is recorded and acts the same as a lien on the property. The equity in the home cannot be seized by a successful plaintiff, since the home itself is subject to the option to purchase for the amount of the loan on the house. Under this agreement you can live in the house without restraint and subject only to whatever terms are provided in the option agreement. There are a number of issues which must be addressed in this type of strategy but this example gives you an idea of the direction that planning can be taken.
Summary
Shielding the family home from the risk of lawsuits necessitates consideration of income tax and local property tax issues as well as your State homestead law. A Personal Residence Trust may provide a good resolution for many of the complex problems which typically arise when dealing with a home. If you feel that you have a potential degree of lawsuit exposure or you have substantial equity in your home, then you should consider some of the strategies discussed in this article. You should contact an experienced asset protection lawyer to ensure that your trust is drafted properly.
In another article I will be addressing the concept of equity stripping.
