Is there a best way for protecting real property? The quick answer is no, because there are so many variables to consider. Is it a personal residence or an income-producing property? How much equity is in the property? Which state is it in? How well do you want to protect it? Are you willing to sell it to protect the equity? How aggressively would your creditors go after the property?
Real property is the most difficult asset to protect. Ownership of real property is public information, what you do with it (like a transfer into an asset protection structure) is likewise public information, and a local judge will always have jurisdiction over the property. Because it is not possible to make real property unreachable by creditors, the most important initial consideration is to understand what your true objective is. If your primary objective is to preserve the financial value that the real property represents, then perhaps selling the property and protecting the cash proceeds is the best option. If you want to try and hold on to the property, then asset protection structures should be thought of as obstacles that will make it more difficult and expensive for creditors to foreclose on the real property, but no asset protection structure will make it impossible.
There are several commonly used structures to protect real property, including trusts and LLCs. What are the different pros and cons of a trust versus an LLC for protecting real property?
A transfer of any asset to an irrevocable trust is usually more protective than a transfer to an LLC. When you transfer an asset to an irrevocable trust, you no longer own it, which is a great asset protection result. When you transfer an asset to an LLC, you still own something – the LLC interest. An LLC interest is generally a more protected type of asset than most anything else, but it is still an asset that appears on your financial statement. As a starting point, we prefer trusts over LLCs given the greater level of protection. There are some other considerations to take into account.
If we are protecting a primary residence, we want to make sure that the transfer of the residence into an asset protection structure does not trigger the due on sale clause in the mortgage. A trust transfer is more likely to avoid this trigger compared to an LLC transfer, and it is our preference to use trusts for primary residences. Because asset protection trusts are always irrevocable, it is likely that a transfer to an asset protection trust (and likewise a transfer to an LLC) will make the homestead exemption inapplicable, and consequently these structures should be used only if there is significant equity in the property. Irrevocable trusts can be structured to have no tax consequences, so that your life is not made more complex.
Asset protection trusts should be established for the benefit of a third-party (like your children) and because you (the person setting up the trust) cannot be the beneficiary of the trust, if the trust holds income producing property, the income will be trapped inside the trust. For clients who need access to the income flow from their properties, an LLC will be a better option. Sometimes we split the baby to gain a somewhat higher level of protection while retaining access to some of the property’s cash flow. This is accomplished by having an LLC hold title to the real property, and then using an irrevocable trust to hold a partial interest in the LLC.
The rule of thumb is to use a trust to protect a personal residence and an LLC to protect other types of real property. But there are a significant number of considerations to take into account, and you should always speak to someone who has experience in completing these transfers.
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