Protecting Your Home

Even in today’s market, your home is likely your most valuable asset.  It is also your most important asset.  Not only does it provide necessary shelter and comfort, but it is an outward manifestation of your very existence.  Sentimentally, your house is priceless.  Of all your assets, your house is the most important to protect from frivolous lawsuits (i.e. traffic accidents, former employees, professional malpractice) and creditors (i.e. unpaid health care bills).  Ironically, your house is also the most difficult asset to protect.

You may be under the mistaken assumption that your house is somehow protected from creditors and/or bankruptcy in the form of a “homestead exemption.”  Only a few states – such as Florida and Texas – provide an unlimited homestead exemption for your personal residence (this is the primary reason O.J. Simpson moved from California to Florida in the wake of his loss in a wrongful death lawsuit).  In California, the homestead exemption is limited to $75,000 in equity for a single person, $100,000 in equity for a family, and $175,000 for homeowners over 65 or disabled.  As a result, if a creditor has a claim against you for more than the homestead exemption amount, the creditor can force the sale of your home.

The most common form of asset protection for real property – a Limited Liability Company or “LLC” – is typically unavailable for your house due to the requirement that you must have a “business purpose” in order to form an LLC.  You ordinarily do not have a legitimate “business purpose” when it comes to your personal residence.  (If you have a true home office or rent out a room or a guesthouse, you may have a legitimate “business purpose,” but there are other potential problems with transferring your personal residence into an LLC.)

A popular  form of asset protection for your home is a practice known as “equity stripping.”  The basic idea behind equity stripping is to take out a loan against your house in an amount that leaves little or no equity.  Your home thus becomes “valueless” in the eyes of a creditor.  You can invest the liquidity in rental property or other assets that are easier to protect with the use of LLC’s or other structures.  The most common form of equity stripping is to take out a Home Equity Line of Credit (“HELOC”) on your house, which can also provide liquidity for emergencies or unexpected financial obligations.

Another method for protecting your home is to establish a Domestic Asset Protection Trust (“DAPT”).  Only 11 states – such as Nevada and Delaware but not California – allow DAPT’s.  Nevertheless, many clients still place California homes in an out-of-state DAPT on the theory that doing so is better than leaving the house completely vulnerable.  An even stronger barrier is to combine equity stripping with the use of a DAPT, making it much harder for a creditor to go after the home and thus much more likely to settle or give up all together.

As with all asset protection planning, you should always employ equity stripping and DAPT’s long before there is any hint of a potential lawsuit.  It is best that any such transaction is “old and cold” by the time a creditor asserts a claim.