One major “hole” in many real-estate investment plans is a provision for protecting your own personal residence. If you’re lucky enough to live in states with homestead exemptions, this is less of a concern — however, if you don’t, the amount and type of protection you need should be a priority in your investment planning.
If this is your situation, beware of the insurance professional who says, “No problem. An umbrella policy will protect you.” However, this is a red flag you’ll ignore at your peril. Why? Because, frankly, this approach is naïve in the extreme: it doesn’t take into account a couple of things.
- One, that the day-to-day mindset of most insurance companies can best be described as, “Deny all claims until forced to pay.”
- Two, whether a claim in question will actually be covered under your “umbrella” policy. Many things aren’t: contract disputes, defaults, environmental claims, and bankruptcy are just a few of the things many umbrella policies don’t cover.
In these cases, an “umbrella” policy can still leave you figuratively “all wet” — a place you don’t want to be financially. Consider this cautionary tale:
I was recently contacted by a man — we’ll call him Joe — whom I first met a few years ago in one of my asset-protection workshops. At that time, Joe was living as a “high roller” with his investments, and he didn’t want to spare the time to think about asset-protection planning. If I recall correctly, his CPA had even told him that such entities could complicate his life, and he needn’t bother with them if he had sufficient insurance.
Fast-forward a few years, however, and Joe’s situation has changed completely — not for the better. He’s in the process of losing not one but five properties to foreclosure. And, to make matters worse, his lenders have flatly denied him the option of a short sale. Turns out that they performed an asset search, and…you guessed it. They found $400K in equity in Joe’s personal residence — and they want it.
So, that’s what his umbrella policy is for, right? Well, as it turns out, Joe’s CPA was dead wrong; Joe’s insurance doesn’t cover a deficiency judgment. (So much for all that “protection” he had!)
Unfortunately, I couldn’t help Joe. The horse had left the barn: i.e., he knew he was about to be sued, and so any “asset planning” in which he engaged at that point would be considered fraudulent. He stood to lose much, much more than discretionary investment funds — all through lack of taking simple actions that could prevent it.
The potential of Joe’s nightmare is all over the place, in all kinds of investment situations. Fortunately for you, though, it’s easily avoidable. Your answer can lie in one of these protection vehicles Joe could have used.
1. Home Equity Line of Credit
How does going into “debt” on your equity keep your house in your hands? Well, the key here is applying for a home equity line of credit with a bank different from those that hold your investment loans. When you take out a line of credit, the lender secures it against the equity you have in your residence via a deed of trust. When a creditor does an asset search, your home shows up as “encumbered,” thereby losing its attraction as a potential asset.
2. Friendly Line of Credit
A friendly line of credit is an interesting relative to the home-equity line of credit. It shares much the same process and principle, with one exception: your own entity serves as your “bank.”
In today’s lending climate, it’s hard to get more than 75 percent on a home equity line from a banker — if you can get it at all. Enter the convenient “workaround”: an entity in Wyoming or Nevada, created by you, of which both ownership and control are anonymous. Once created, this entity enters into an equity line of credit with you, you provide your personal residence as collateral, and the entity records a deed of trust against that residence in the amount necessary to protect it. From the creditor’s point of view, once again, your residence is “encumbered” by a Wyoming or Nevada entity, and less attractive.
The good thing about this strategy? You’re in full control of the credit line, so you can increase it or release it at any time. The not-so-good thing? If you’re being sued, this strategy doesn’t protect you unless that Wyoming or Nevada entity actually “loans” you money.
3. Land Trust with a Wyoming Limited Liability Company
If you have been reading my posts, then you are aware of how a land trust is an excellent tool to remove the title from your name thereby turning your real property ownership into personal property as the beneficiary of the trust. This beneficial ownership can, in turn, be quietly assigned to an entity thus, divesting yourself of ownership and protecting yourself from liability associated with the real property. This strategy is used by thousands of investors every year for protection from creditors and to move encumbered real property under an LLC shield without alerting the lender to the move.
This same strategy can be used for your personal residence. By moving your residence into a land trust followed by a transfer of the beneficial interest to a Wyoming or Nevada LLC (disregarded for tax purposes) you place a shield around a treasured asset. Is this foolproof? Not necessarily but it does create a roadblock, and part of an excellent asset protection strategy is about building walls to keep out the uninvited, or at least make it seem extremely uninviting.
4. Qualified Personal Residence Trust, or “QPRT”
As its name implies, this trust is set up to hold your personal residence, and it’s mainly considered an estate-planning tool because of how it works. A QPRT functions a couple of different ways:
- you can transfer a residence to a trust, but retain the right to live in the residence for a specified period of years, or
- you can sell the home and buy a new one, or convert the funds to cash.
At the end of the set period of years, your children become the residence owners, and the residence ceases to be a part of your taxable estate. The ancillary benefit — which most attorneys miss! — is that placing a residence in trust effectively removes it from reach of the original owner’s creditors right now, today.
These are just three options I use to help clients protect a crucially important asset from the possibility of attachment. However, the time to start planning these things is now…BEFORE the “hounds are at the door.” A word to the wise!