House Protection from Lawsuits

House Protection

House protection from lawsuits is an important question.  Asset protection freaks are always asking me if they should, or telling me that they did, put their house in a corporation or Limited Liability Company (LLC). This is a big mistake. They are losing valuable tax benefits.  They have confused the purpose of asset protection using a company shield, whether it’s a corporation or LLC shield.

Company structures are creations of Congress. They are intended to protect the shareholders (investors) and the managers from personal liability if something goes wrong with the company. The object is to encourage people to take the risks associated with running a business and financing companies. Congress didn’t pass the laws associated with companies for personal “asset protection.” The company only protects against acts done in the pursuit of the business’ activities.

Owning a home isn’t a business activity. It is a personal activity. The home isn’t “doing business,” so activities associated with home ownership won’t be the types of activities that a corporate structure is designed to protect against. What corporations protect and don’t protect is a strange concept to a lot of people. The bottom line is the business structure isn’t for house protection and it won’t protect you against activities or problems that occur at the house.

Additionally, putting your personal resident in a business entity is a tax disaster. Suddenly, it isn’t a personal residence any more. It is a piece of real estate owned by the company that you happen to live in. If you don’t pay rent, the IRS will attribute rent and thus you will have income to the company. Additionally, since it isn’t a personal residence anymore, there isn’t any advantageous income tax deduction for interest paid. There also isn’t any step up in basis in the value of your home when you die.  If you live in a personal residence for two out of five years, when you sell it there is no income tax consequence. If it’s not a personal residence, but a company property, you lose this benefit and pay full bore taxes on it.

By the way, it is ok to put the residence into a living revocable trust (not a land trust), because federal law specifically states that if a “grantor trust” is used, which a living revocable trust usually is, then there are no tax consequences resulting from a transfer of property into the trust. The trust is simply transparent to the IRS for income tax purposes.

The way to get house protection for a personal residence from lawsuits is to carry a large liability policy with a good umbrella provision. To protect it from business bankruptcies, etc., move the ownership of the asset (the residence) into the name of the spouse that isn’t in the business. Keep that spouse’s name out of the business records. Try real hard not to have that spouse sign on business loans. That spouse shouldn’t be an officer or director (manager) of the business entity. When the business has problems, only the assets of those involved in the business are at risk. (Unless you are in a community property state.)

How you own property  for house protection is critically important.  My book, Protecting Your Financial Future, deals in detail with ownership in the context of trusts so you can get the proper house protection.