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Home Protection

Home Protection – Protecting the Personal Residence
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.

Homestead Exemption

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 (the explanation of which is in the detailed summary) 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

1.The client could lose their capital gains tax exemption of $250,000 per spouse when selling the home.
2.The client is at risk of losing their ability to write off taxes and the mortgage payment.
3.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 (especially when coupled with the proper mortgage product ) if clients take the borrowed funds and invest them in something that will grow tax free and come out tax free in retirement.

For a real eye opening experience about the value of debt shields, read the The Home Equity Management Guidebook – Paperback Version.

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. Click here for our Mortgage – Equity Harvesting Course.

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).

Why is your personal residence at risk?

It depends on the state you are in, but as a general rule, in most states the interest in your home is subject not only to your creditors but that of your spouse.

If you or your spouse are a professional (doctors, lawyers, accountants/CPAs, insurance agents, financial planners, mortgage brokers, real estate agents, architects, etc.) then you have the added problem of having “professional” liability which puts all of your assets at risk every time you go to work (including the home). If you own a non-professional company, the work done, as a general statement, does not put your personal assets at risk.

How else could your home be at risk?

As a homeowner, you typically will throw a few parties each year for your friends. If you serve alcohol at those parties and one of your guests leaves the party after drinking too much and gets into a car accident and kills three passengers in the other car (or turn them into quadriplegics), guess who is going to get sued for negligence? The homeowner. Most people think that an umbrella liability policy of 1 million dollars will protect them; but, if you can be linked to a death or serious injury through your negligence, your 1-million-dollar umbrella is not going to go very far. After your insurance pays 1 million of the 3–million-dollar verdict, the attorney for the plaintiff is going to go after all of your personal assets.

Teenage Children – If you have teenage children, chances are, at some point, you will go out of town and your children, whom you left home (the 16-19 year olds), will have a party or have friends over. Since the statistics say that over 50% of teenagers drink on a regular basis (many times binge drinking), the chances are high that there will be alcohol at the party at your house. If your children are the ones who procured the alcohol (and maybe even if they did not) and the attendees at the party get drunk and then drive around and get hurt or hurt others, guess who is going to be sued? The parents. Again, the 1-million-dollar umbrella policy from your homeowner’s policy is not going to go very far to protect you.

There are plenty of other reasons to asset protect your personal residence.

Asset Protection for your home

The most difficult asset to protect is your personal residence. If you surf the Internet, you’ll find very little information about protecting your home due to the fact that there are few viable ways to protect the home.

If you surf this site and others you might come to the conclusion that using and LLC or FLP is the right tool to protect the personal residence.

The main way to protect your personal residence is through a “debt shield.” Debt shields (also known as equity stripping or equity harvesting) not only asset protects your personal residence, but it can also work out as a terrific way to build a tax favorable retirement nest egg.

QPRT: Qualified Personal Residence Trust
It is possible to place your house in a trust, continue to live in it and save big money on estate and gift taxes. It is not too good to be true, just good enough to be true. If you have a cohesive family and you plan to leave your house to those family members, you should definitely investigate this technique.

This was enacted by the legislation of Congress for tax reduction and stands as one of the many options for estate planning today. That is as long as the legislation for tax reduction stands. As with all legislation, it could be gone tomorrow. QPRTs are “tricky” because much of their success relies on timing and prediction.

– A QPRT is removing the residence from the donor’s estate at a reduced transfer tax and placing it into a trust for a specific period of time. It is especially beneficial if the residence is expected to appreciate over time.

You deed your house to a type of trust known as a Qualified Personal Residence Trust or a QPRT . You preserve the right to live in the house for a certain, specified term or a certain number of years. At the end of this provision, the house passes to your children or another named beneficiary. This is a great reduction of federal or state taxes and gift taxes with certain limits. If you do not survive the term (due to death), then the house will be returned to the estate as if it were never part of the trust in the first place and therefore will be subject to estate taxes.

The QPRT affects an estate tax freeze, a discounted gift tax value, and permits the donor to live in the house just as before. When the donor dies, the house passes to the beneficiaries at fair market value with the old income tax basis, thus avoiding major taxes.

If you notice the word “donor” instead of the plural “donors”, delving into the details and rules of a QPRT it is possible to create two QPRTs, one for each spouse. Remembering that a QPRT is only viable when the donor survives the term, which would mean that half of the benefits would be transferred into each QPRT and then the same rules apply.

If the donor survives the term, he or she can occupy the house at fair market value for the rent share. Be aware that this rent payment is subject to capital gains, therefore potentially canceling out some of the savings.

Equity Stripping
Protecting your Home and other real estate requires preemptive decision-making regarding the many options available. It is never as straight forward as moving cash or cash equivalents. The time-tested method of protecting your home has always been to strip the equity from the property.

In the past, having equity in your home or a paid-for property was something to rejoice and tell your neighbors about. Today, with the ongoing litigation explosion, you are advised to protect your home with much less fan fair. The reality is, when you have the slightest bit of equity built up in your home it will most likely be available to creditors.

If you are fortunate enough to live in a state with a generous homestead exemption, that portion of your home’s value will be protected from creditors. Assuming that you may be able to get a loan against your property for a good percentage of the value of your home and then add in your homestead exemption, you may be able to get fairly close to the total value of your home.

A good example would be: if you live in California and you are married you can get a $250,000.00 Homestead exemption. Take a $750,000.00 home and put a $500,000.00 home equity loan against the property and viola, you have now made your home a very unattractive asset for a creditor.

If you end up on the wrong side of a court decision, the creditor will look at your property records and estimate the value of your home, the homestead exemption, the resulting equity and decide foreclosure is to time consuming and expensive.

Equity stripping or Equity Harvesting can be a pleasant solution when done properly. It may sound odd but putting on debt can result in great asset protection as well as great wealth transfer planning. Ideally, Equity Harvesting done correctly uses a “tax favorable” investment. Without belaboring the point in this brief article, 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).

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