Protecting a personal residence depends on the particular circumstances pertaining to each asset and because most people value their residence and place it at the top priority for protection, the subject is very serious and must be treated with utmost care.
There is no one way to protect a personal residence and there is only one way that stands tested to the end every time. We will present a few so that you can compare the techniques to the one that is superior.
Experts speak of the Homestead Exemption frequently. As a general statement, the homestead exemption is very limited in most states because it only protects $5,000-$10,000 of your homes’ value. In states like Texas and Florida, there is an unlimited homestead exemption that protects the entire value of the house (with some new exceptions under the bankruptcy laws). Other states are more favorable with property protection from $100,000 to $500,000. The laws vary state by state.
Tenants by the Entireties(TE)
States like Michigan allow married couples to own property titled as “tenants by the entireties” (TE). Owning property as TE means that each spouse has an undivided interest in the “whole” property. Even though each spouse owns 50 percent of the marital residence, they each have an undividable right to use the whole property.
A creditor cannot force the sale of either spouse’s interest because to do so would affect the other spouse’s enjoyment of the “whole” property. Therefore, if you live in a state where married couples can own property as TE, then by good fortune, you and your client’s marital residences can be protected from many creditors.
TE does NOT protect the marital home from joint creditors (of which there are many). Therefore, we do not recommend that clients rely on TE to protect their personal residence.
Qualified Personal Residence Trust (QPRT)
A QPRT is an “Irrevocable Trust.” With a QPRT the client gifts their home to QPRT and then lives in it for a period of years rent free. After that period is up (usually the period is for a minimum amount of years), the client ends up paying non-deductible rent to the beneficiaries of the Trust and could actually be evicted from the home. A QPRT is an interesting but flawed as a useful estate planning tool and it should not be used as an Asset Protection tool.
LLCs and FLPs
It is absolutely amazing how many advisors recommend that clients should transfer their personal residence to an LLC or FLP for Asset Protection purposes. Because many believe in the charging order protection afforded some LLCs/FLPs, it seems in vogue to make the recommendation.
It’s a terrible idea for most clients because
The client could lose their capital gains tax exemption of $250,000 per spouse when selling the home.
The client is at risk of losing their ability to write off taxes and the mortgage payment.
In some states the property taxes nearly double if the home is not claimed as a homestead.
Debt Shields (Equity Stripping/Harvesting)
While Debt Shields and Equity Stripping sound fancy or exotic, the terms simply stand for taking out a large loan on an important asset that has either no, or very little, debt.
The theory behind Debt Shields is simple: If an asset is laden with debt, a creditor will not want it. If a creditor does want it, he or she will have to stand behind the first creditor holding the loan against the valuable asset.
Debt shields have been around for some time, but few advisors know how to properly use them. A debt shield (also known as equity harvesting) is a fancy term for taking out a large loan on the home so no creditor will want it. If your home has a huge debt on it, will a creditor want to seize that asset?
Most clients are adverse to debt and to mortgage payments. However, a debt shield can also be a terrific wealth building tool if clients take the borrowed funds and invest them in something that will grow tax free and come out tax free in retirement.
A client with equity in their home takes out additional debt on the home, thereby stripping the equity out of the house. Clients can do this through a home equity loan or by refinancing the home’s debt.
It may also be wise to learn the ins and outs of mortgages and to avoid the many pitfalls. We want you to know what your mortgage broker knows.
Ideally, Equity Harvesting, done correctly, uses a “tax favorable” investment. Without belaboring the point in this brief example, the tools of choice typically are life insurance (because the money can grow tax-free and come out tax free) and annuities (because of tax deferred growth).
Financial Risk Analysis
Investments Too Risky?
It’s tough to determine which investments to use if you don’t know your own risk tolerance.