Protect Your Home From a Lawsuit in California
At this time, California ranks as one of the most litigious states in the Union. Do you live in the Golden State? Do you work in a high-risk field? If so, you need to be thinking about how to protect your home from a lawsuit in California. In this context, a high-risk field refers to arenas like medicine or the construction industry. In these professions, practitioners face a greater exposure to lawsuits than professionals in other industries. Sadly, however, in these litigious times, it sometimes seems almost any professional field is a high-risk one.
California is a partial homestead state. This means as a homeowner, you can claim a certain portion of the equity of your primary residence. That portion is exempt from a judgement resulting from a lawsuit that has been waged against you. The problem is that housing prices are very high in California compared to other states. So, many homeowners find much of their equity exposed. Thus, the homestead protection in California is a way to secure only some of the equity in your home from a lawsuit.
You need to be careful in determining the steps you must to take to avoid losing your house in a lawsuit. Make sure the asset protection vehicle you choose to secure your home will not jeopardize the tax benefits you enjoy as a homeowner. It may end up costing you more in taxes. There are tax-neutral ways to gain privacy and protect yourself, such as with land trusts and equity stripping.
California Homestead Exemption
A homestead is simply your primary place of residence. It could be a single-family house, a condominium unit, a mobile home or even a boat. California provides an automatic homestead exemption ranging from $50,000 to $150,000. The exact amount would depend on your age and marital status as well as whether or not you have a disability. California’s homestead exemption is low compared to other states. Massachusetts, for example, allows a homestead exemption of up to $300,000. While Texas and Florida do not have a ceiling limit as to the amount of homestead exemption to which a homeowner is entitled, depending on the size and location of the property.
California’s has a lower level of homestead exemption. If the equity in your house falls within the limits set by the state, your house may be safe for the time being. Depending on your particular situation, however, further action may be necessary to protect your home from a lawsuit. Even if a creditor receives a judgement against you, he or she will not initially be able to take your house to satisfy your debt. However, judgments last for 20 years. And if the house goes up in value during that time, it gives your judgment creditor a big incentive. Then can then seize your house and sell it to satisfy at least some of the judgment.
Keep in mind, however, the equity in your house may currently exceed the homestead exemption in the state where you live. Thus, the amount over the exemption limit is not safe from a lawsuit. A creditor with a judgement against you can legally force you to sell your house. They can turn the equity into cash. Then, they can use part or all of it to satisfy your debt.
California has an automatic homestead exemption on a portion of the equity with every home purchase. For added protection in certain instances many professionals advise their clients to ‘declare’ their house as homestead. This may be advisable when your home is placed into a trust, for example. You may file this declaration at the county recorder’s office. The declaration must be notarized before filing in order to be valid. Any fines or tax arrears attached to the property will be taken into consideration when determining the exact amount of your homestead exemption.
The Limited Benefits of Homestead Protection
Homeowners know, and no doubt appreciate, the tax advantages that come with owning their own home. While you own and live in your home, you are entitled to a mortgage interest tax deduction. When you do finally decide to sell your house, you may be qualified to exclude up to $250,000 in capital gains if you are single; $500,000 if married. The amount would naturally depend on where you live. It may consider your particular financial situation at the time of the sale, and, as stated, your marital status.
California is one of the states that does not allow a reassessment of your home’s value unless and until there is a clear change of ownership. This means, property taxes can go up each year within certain parameters. It may not necessarily in lockstep with its actual appreciated in value. For many homeowners, this is a lifesaver. Not everyone who bought their houses decades ago at unbelievably low prices – at least by today’s standards – can afford to pay the taxes on what their homes would be currently worth in the open market. This is especially true after the real estate market’s recent, and continuing, rebound in virtually every state.
And herein lies the challenge. Thanks to the recovering real estate market in California, you likely now have equity in your home. It may well exceed the amount set as a homestead exemption in the state. When transferring your house to a trust, submit the proper supplemental filings to the county. As a result they usually do not consider the transfer a change of ownership. This means your home will, henceforth, would not necessarily be subject to higher taxes based on its current assessed market value.
LLCs? Not for Personal Residence
A limited liability company is ideal for owning rental property. But not for a primary residence. Transferring it to a corporation or an LLC would likely be seen as a change of ownership. This may trigger a tax reassessment. This amount may be higher if your house has appreciated in value through the years. Protecting your home from a lawsuit by placing it in a company, may affect the tax advantages of being a homeowner as well.
In taking steps to make sure you do not lose your house in a lawsuit in California, be mindful that you do not end up forfeiting the tax benefits you enjoy as a homeowner.
Land Trust: Privacy of Ownership
A land trust is a means of homeownership that keeps your name out of the public records. It is a privacy tool. What is the first thing a contingent fee lawyer does when considering taking a case against you? They do is an asset search to see if you are worth his while. If the assets search turns up an expensive house with gobs of luscious equity, it’s “game on.” However, what if your house is in a land trust? Your cars are in title holding trusts? You don’t have pictures of yourself on Facebook flying around in your private jet? In that case, the attorney is less likely to take the case on a contingency.
Protecting Your Home: Equity Stripping
By placing a large mortgage on your house, you strip it of its equity, making it a less attractive target. Technically speaking, in California this is a “deed of trust” rather than a mortgage. However, most people use the word “mortgage” in everyday language, so that is the word what we will use here. You can place the proceeds of the mortgage into the most powerful asset protection tool: the offshore trust. Read more about the benefits and safety of the offshore asset protection trust on this website.
Alternatively, this organization can set up an LLC for you. You can own it privately or hold it in your asset protection trust. That LLC will record a home equity line of credit (HELOC) type of mortgage against your property. Have you ever heard of one bank acquiring a mortgage from another? You know, “We have acquired your mortgage, now start sending the payments here?” When you are in hot water, you can protect yourself by making the same thing happen to your HELOC.
How it Works
Here is how it works. When the “bad thing” happens, there is an international institution that can acquire the mortgage from your LLC. Next, that institution can show a distribution of the cash from the HELOC. Put it into your offshore trust into a “don’t touch it” account. In other words, you can show the courts where the money went. But the courts cannot touch the proceeds because they are protected inside of your offshore trust.
Naturally, you would not be able to spend the cash proceeds until you sell or re-fi, the property. After all, the bank is not going to risk cash secured by a house in another country. The mortgage can go away by asking your trustee to seek its removal. Or you can pay off the loan (again, through sale or re-fi), thereby releasing the cash proceeds to your offshore trust.
Why don’t I just put my house in the offshore asset protection trust? The reason is that the real estate is under the jurisdiction of your local courts. So, a judge can say, “That’s great that you have this trust but I’m going to let them take it anyway.” However, with a legitimate mortgage, that presents a different scenario. Using the above steps, you have effectively stripped the equity. This places the resultant proceeds beyond the reach of the courts inside of an offshore trust.
Qualified Personal Residence Trust (QPRT)
The Qualified Personal Residence Trust (QPRT) is a type of irrevocable trust. It is a relatively new asset/estate planning tool. It permits homeowners to continue to live in their property while at the same time divesting themselves of home ownership. Since you no longer own the property, you have effectively placed it beyond the reach of future creditors. A judgement or lawsuit cannot attach your home. The caveat is that there are restrictions on being able to sell or move out of the home during your lifetime.
Under California state laws, as long as the trust settlor continues to live in the house, there has not been a change in ownership. This is true even after the settlor deeds the house to the QPRT. Because there has been no change in ownership, the county will not assess the property at a higher tax rate. Additionally, the IRS treats the QPRT as a grantor trust. This is because the settlor of the trust continues to receive some type of benefit from the trust assets. After all, he or she still lives in the house. Because of this and for the duration of the trust term, the (former) homeowner can claim an income tax deduction for any real estate taxes that he or she pays.
Added Benefits of a QPRT
After you establish the QPRT you deed the house into the trust. The trust sets the number of years the settlor lives in the house. If the settlor is still alive after that prescribed amount of time, he or she can pay rent to the trust beneficiaries (such as his or her children) and continue to live in the house.
You can include a provision for this lease when you establish the trust. This can assure the settlor that he or she can continue to live in the house even when the designated number of years has lapsed. In addition to the practical aspects of this arrangement, it provides trust settlors assurances. The most important of these is that they will not be left out in the cold and unprotected. This is especially important when they reach the age that they need security the most.
The retained interest of a QPRT refers to the benefit that the settlor enjoys from the trust. That is, reserving the right to live in the residence for a period of time. The remainder interest refers to the benefits that go to the beneficiaries at the end of the trust term; that is the property itself. The value of each interest correlates with the length of the trust term.
The longer the trust term, the larger the value of the retained interest and, conversely, the smaller the value of the remainder interest. This is significant for gift tax purposes. A small remainder interest means your designated beneficiaries will end up paying lower gift taxes – if at all. As of 2011, the gift tax exemption stands at $5 million, so it’s highly unlikely that your property in the QPRT will result in a gift tax liability for your beneficiaries at the end of the trust term.
Can You Lose Your Home in a Lawsuit in California?
As we have stated, the answer is most definitely, yes, it is possible. But with careful advanced planning, the odds of keeping your house safe from predatory claims are vastly improved. Filing a homestead declaration is an easy and affordable way to place an extra layer of protection between your property and a frivolous lawsuit. Whatever steps you decide to take in protecting your house from a lawsuit in California, be sure to weigh your options carefully.
Establishing a QPRT is one strategy to keep the tax benefits of homeownership and enjoy the asset protection features of an irrevocable trust at the same time. It has the added advantage of significantly reducing the amount of gift taxes that your beneficiaries will be required to pay at the end of the trust term. More importantly, when properly set up, a QPRT provides settlors with security and peace of mind, knowing that for the rest of their days, they can continue to live in the house they have learned to call their home.