For those who own a home, this is probably the largest source of equity, and with the housing market fluctuating as it is right now, protecting this asset is critical. There are ways to protect your home from risk of lawsuit and this article addresses the vehicles that can be used.
Exceptional Considerations
A residence has certain exceptional legal qualities that differentiate it from any other type of property. To protect the home from liability threats, several crucial factors must be considered.
continuous enjoyment
A properly written asset protection plan will allow you to continue living in your home.
property protection
Some states have housing 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 individual property and $331,100 for joint property. In California, the amount is $75,000 for individual ownership and $100,000 for joint ownership. Massachusetts allows $500,000. Eight states allow unlimited protection. New Jersey and Pennsylvania do not have any protection. If your home equity is less than the amounts allowed in your state, then no further asset protection is needed. If not, you should consider other avenues.
Plans that don’t work
If you place your residence in a family limited partnership or limited liability company, the IRS has ruled that some or all tax advantages may be lost. Also, if a property is placed in an FLP and is reserved for personal use, the protection afforded by the FLP could 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 amount of ownership while retaining tax benefits and the continued right to use and enjoy the home.
The best type of trust for this type of asset protection is a grantor trust. In this case, the trust is not the owner of the property. The trust should be honored for protection purposes but ignored for taxes.
After solving the tax problems, the next step is the actual protection of the assets. It is important to remember that you, as the owner, cannot hold the full spectrum of property rights. If you do, a judge will likely 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 some alternatives to this situation that can protect your home.
Personal Residence Trust
A personal residence trust is a generic term that applies to a trust to hold property and employ restrictions that protect it against potential loss. This type of trust is considered ignored for tax purposes, so tax problems are not created and tax benefits are protected. There are many different designs and strategies that can be used to create this type of trust, depending on the specific circumstances of the case.
An alternative is to allow the PRT for your children or other family members to take possession of the house after a certain number of years. The trust gives you the right to live in the house for a period of 10 to 20 years. Under the terms of the trust, there can be some great tax benefits from freezing the value of the home at its current amount and thereby removing it from your taxable estate. The number of years and other important terms may be modified to meet specific circumstances.
Another alternative is to allow the trust to own the house and rent it to you for a certain number of years. In the event, you will pay rent to the trust and the normal tax benefits still apply because the grantor trust rules. At the end of the lease term, full ownership reverts to you or passes to your children.
In a slightly different version, the PRT could be given the opportunity to purchase or the right to exercise some other right to the property within the trust. As an example, the Personal Residence Trust is created which gives the trust an option to purchase the property for the amount of the loan, at any time within the next 15 years. The option agreement is recorded and acts just like a lien on the property. The home equity cannot be repossessed by a successful plaintiff, as the home itself is subject to the option to purchase for the amount of the home loan. Under this agreement, you may live in the home without restrictions and subject only to the terms provided in the option agreement. There are a number of issues that need to be addressed in this type of strategy, but this example gives you an idea of the direction that planning can take.
Summary
Protecting the family home from the risk of lawsuits requires consideration of income tax and local property tax issues, as well as state property law. A personal residence trust can provide a good solution to many of the complex problems that often arise when it comes to housing. If you believe you have a potential degree of exposure to lawsuits or 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 attorney to ensure that your trust is drafted correctly.
In another article I will address the concept of dispossession of equity.
