Home Residential Title
Your primary residence is probably the most valuable asset you own, and how it is titled can have far-reaching effects that may not be immediately obvious.
The “title" of real property is a legal ownership description that specifies who owns the asset and what happens to the asset ownership upon death. The title documents also determine how the property can be financed, used, improved upon or used as collateral.
While many homebuyers either aren't aware of their options for titling their property, a well-thought-out asset titling strategy for asset protection and inheritances, can minimize your exposure to taxes, better protect your asset and ensure that upon death your wishes are carried out in the simplest and most efficient way possible.
How you decide to title your assets will depend on the nature of the asset in question and what it is you want to accomplish, both when you are living and when it comes time to transfer the asset after your death. Failing to properly title your home can lead to unintended consequences. Whether you're refinancing or purchasing a new home, getting the titling right at the outset is critical. Below is an overview of the most common forms of ownership.
Sole Ownership - the property passes automatically to surviving owners but suffers from legal implications if the owner becomes incapacitated and at death. There is no asset protection and as such, Sole Ownership is vulnerable to legal claims.
Joint Ownership - the property passes automatically to surviving owners but suffers from legal, and tax implications. Once so named in the “title” it is not possible to unilaterally remove joint tenant resulting in divorce problems as the property will most likely need to be sold. Moreover, there is no asset protection and it is doubly worse as the Creditor of one tenant may attach the property.
Joint Tenants-in-Common - This title is useful for non-related parties to co-own the property. The property passes automatically to surviving owners via Trusts, Wills, however, the property is subject to probate at death of an owner whose interest is titled in his or her individual name. Moreover, there is no asset protection and like Joint Ownership it is doubly worse as the Creditors of one tenant may attach the other tenant's interest.
Living Trusts - Transferring the title of a home to a living trust will only protect it from a lawsuit judgment if the terms of the trust are irrevocable. The permanence of an irrevocable living trust makes it one of the more extreme asset protection strategies. An alternative option is to create an irrevocable qualified personal residence trust, or QPRT, which allows you to retain a tenancy interest in the home. With a QPRT, you still transfer title to your home, but you retain the right to reside in the home for the period you specify in the trust document. Your right to occupy the home is an interest that has value, but a QPRT remains an effective strategy for protecting the full ownership rights of the home from judgment creditors. Moreover taxes are minimized upon an owner's death and the Trustees can buy, sell and refinance real estate at their own discretion.
Skipping the Probate Process
Probate is the name for the formal court process through which your estate is passed on to your heirs after death. Depending on where you live, it could be a relatively quick process or it could be long and drawn out - up to 24 or longer. By making sure that your assets are titled in a manner that skips this process entirely, you may save your heirs a lot of time, effort and money.
Certain types of ownership allow you to pass control of your assets to a joint owner, such as a spouse, without having to go through probate. These include:
- Joint tenancy with rights of survivorship (JTWROS)
- Joint tenancy by the entirety
Not all types of joint ownership function this way. For instance, if an asset is titled as joint ownership with “tenants in common," the surviving owner does not automatically take ownership of a deceased owner's share of the asset — the ownership is determined by the decedent's will.
You may also transfer ownership of your assets to a Trust that you've created. Upon your death, the Trust assets would pass directly to your beneficiary without the need for probate.
For example, consider the case of a woman who purchased a new house, valued at $2 million, in California. She held the title as the sole owner and relied on her will to pass the home on to her children. Upon her death, the children needed to go through the probate process to take ownership of the home, resulting in a minimum probate fee of $33,000. (If there was a personal representative who also chose to take a fee, the cost could be as high as $66,000.) In order to complete the transfer, either the woman's estate or her children needed to come up with a significant amount of money. Had the woman established a trust for the purposes of holding the title to the property, all probate and costs could been have avoided.
Depending on how an asset is titled, it may be eligible for a “step up" in basis when it is transferred. The basis is the original purchase value stepped up to the current market value either by sale or appraisal of the asset. Step ups minimize capital gains taxes. This means that the inheritor will only have to pay taxes on any growth in the value of the asset that occurs after the transfer, should they choose to sell it. Other forms of ownership may only be entitled to step up a portion of the basis upon transfer, depending on the circumstances.
Limited Liability Company
Multiple Member Limited Liability Companies “LLCs” - can be very useful tools for achieving asset protection. For this reason, individuals sometimes consider transferring their primaryresidence into an LLC. There is no law that says you can’t put your primary residence intoan LLC, but there are numerous reasons why it may not be a good idea if your primary objective is asset protection.
LLCs can provide two different levels of asset protection
Inside Liability Protection - If the LLC is sued, the person suing the LLC should only be able to reach the assets that are owned by the LLC. If the LLC was properly structured and maintained, your personal assets should not be available to satisfy the claims of the LLC’s creditors.
Outside Liability Protection - If you are sued and you own an interest in an LLC, and if the LLC was properly structured and maintained, the person suing you should not be able to reach the assets within the LLC. Instead, the creditor should only be able to obtain a “charging order” against your interest in the LLC. A charging order assigns some of your rights in the LLC to the creditor. For example, if the LLC makes a distribution to you, the creditor would be entitled to that distribution. However, this may not be appealing to a creditor because if a charging order was obtained, the LLC’s manager might choose to not make distributions (if this was allowed by the company’s operating documents). In addition, an LLC’s tax liability flows through to its members. If a creditor obtains a charging order, your share of the LLC’s income tax liability will arguably flow through to the creditor, which can be a disincentive for a creditor to obtain a charging order against the LLC in the first place.
From this "outside liability" perspective, the idea of transferring your personal residence to an LLC might appear attractive. After all, if you are sued personally but your primary residence is owned by an LLC, it is possible that the creditor's only remedy would be a charging order against the LLC. However, before you transfer your primary residence into an LLC for this reason, be sure to consider the following.
Following is a summary of issues to consider before you transfer your primary residence to a LLC for the purpose of protecting your residence from the claims of your personal creditors.
Is There a Business Purpose? A LLC is a business and you need to have a business purpose for putting each asset into your LLC. You should not mix your personal and business assets in an LLC. Unless if you plan on paying rent to the LLC in exchange for your continued use of the residence, it is hard to argue that your primary residence is a business asset. If you do not observe proper business formalities, a court could disregard the existence of the LLC. If the LLC is disregarded, you will lose the asset protection benefits of the LLC. If the LLC is sued, your personal assets could also be at risk, and if you are sued, the LLC’s assets could also be at risk. Therefore, by putting your personal residence in your LLC, you could compromise the asset protection for your other personal and LLC assets.
Loss of Capital Gain Exclusion - For the United States, Section 121 of the Internal Revenue Code allows you to exclude up to $250,000 (if you’re single) or $500,000 (if you’re married) of capital gain when you sell your primary residence if you’ve lived in and owned your home for at least two of the previous five years. If you transfer your primary residence to a multiple member LLC, you lose the ability to benefit from this capital gain tax exclusion.
Loss of Property Tax and Mortgage Interest Deductions - For the United States, if you transfer your primary residence to an LLC, you will most likely no longer qualify for property tax and mortgage interest income tax deductions because you no longer own the property (so you can’t take the deduction personally) and an LLC can only deduct ordinary and necessary business expenses (so the LLC can’t take a deduction either). If there is no business purpose for the LLC to own your residence and you do not pay rent to the LLC, the LLC’s expenses incurred to maintain the residence are not deductible.
Real Estate Transfer Taxes - Be aware of your United State’s real estate transfer tax rules. Some states charge a transfer tax where as much as $0.30 tax per $100 of a property’s value must be paid to the States' Department of Revenue upon transfer of real estate to a multiple member LLC, unless if the LLC’s members are related to each other. Another way to qualify for a transfer tax exemption in such states is to form the LLC with you as the sole initial member and then convert the LLC to a multiple member LLC after the real estate is transferred to the LLC.
Loss of Homestead Exemption - If in the United Sates, and you transfer your primary residence to a LLC, it will most likely lose its homestead classification. In some states, such as Florida, maintaining your homestead exemption is extremely important. The loss of your homestead exemption can result in increased property taxes and the loss of the benefit of homestead creditor protection laws.
Mortgage Due on Transfer Clause - If you have a mortgage on your residence and you transfer the residence to an LLC, it could trigger a due on transfer clause and result in your mortgage being immediately due and payable. However, this risk can be addressed by obtaining your mortgagor’s consent in advance of the transfer. Despite all of the above issues, it is possible that in certain circumstances you may achieve asset protection if your primary residence is owned by an LLC. There might also be other estate planning reasons why you want to put your residence in an LLC. However, before you transfer your primary residence to an LLC, please be sure to seriously consider all of the above potential consequences. In many situations there will be a better alternative.
Vacation and Rental Properties - Each of these such properties should be considered to be transferred to its own unique LLC for the ultimate in asset protection. Moreover, there could be a scenario where these properties could be held by an offshore LLC or Personal Interest Foundation. Utilizing this strategy, the valuable equity in the real estate will be effectively transferred offshore - beyond the reach of the local courts. Further, by utilizing this strategy, taxes, inheritances and the like are mitigated.
A Balanced Strategy to Planning
It's important to consider the long-term implications of putting assets in a trust before choosing this path. By titling your assets in the name of an irrevocable trust, you are ceding ownership of them. This may make it difficult, if not impossible, for you to use those assets as collateral in the event you should need to borrow in the future. When designing the trust, work with your attorney to ensure that you've considered your future needs and have drafted documentation that is flexible enough to accommodate them. Once an irrevocable trust is established, you typically cannot make changes to the terms of the trust.
Moving beyond Trusts and into LLC’s requires more understanding and legal set up.
In all issues such as these, it is critical for your estate plan ito consider a well-balanced strategic plan. In the case of your home, you may find that not all mortgage lenders allow title to be held in a trust or LLC. A thoughtful, experienced wealth manager can work closely with your trust and estate attorney, your accountant and your banker to devise a financing strategy that ensures you are able to successfully navigate this complex territory without undermining any aspect of your plan. Together, you and your advisors can evaluate your assets, choose the appropriate titling strategy for each of them and conduct regular reviews to determine whether updates must be made to incorporate new assets or changing circumstances.