Concept #1: Equity & Cash Flow Matter, not FMV
In real estate, your focus should be on equity and cash flow, not on Fair Market Value (FMV). It’s not uncommon for a property to carry significant debt, meaning that the net value or equity in the property can be less than a lower valued, fully paid-off property. For instance, a $3.5 million property with $3.2 million of debt is worth less to the owner than a fully paid-off $650,000 property. This understanding is important for Asset Protection, as judgement creditors are interested in net equity and cash flow, not the gross value of your real estate. Using debt can therefore effectively protect the value of your real estate by reducing your equity and making your property less appealing to a judgement creditor.
Concept #2: Inside vs. Outside Liability
Understanding the difference between ‘inside’ and ‘outside’ liability is crucial. Inside liability refers to issues arising from the property itself, such as a fire or a pool accident. Outside liability, however, has no connection with the property and arises from the owner’s activities, such as a car accident or a business deal gone wrong. To mitigate both types of liability, consider creating a Limited Liability Company (LLC) to hold your property. This isolates the inside liability to a specific property or group of properties, and insulates the real estate inside the LLC from an outside liability.
Concept #3: Separate the Risk from the Assets
One way to protect assets is to separate them from any potential risks. Consider a medical doctor who owns an office building. The doctor’s primary risks are in the practice itself, while the office building doesn’t carry much risk but has significant value. To protect this value, the solution is to put the office building into its own separate LLC. This effectively insulates the valuable asset from the risks inherent to the practice.
Concept #4: Create Layers of Protection
Creating layers of protection is like layering clothing to keep warm in a cold climate. The base layer for real estate protection is the LLC, and a mid-layer is a holding company. A holding company offers benefits such as consolidated tax reporting, reduced accounting expenses, the inclusion of other family members or business partners for estate planning, and increased overall protection by choosing a jurisdiction with favorable laws.
Concept #5: The Bridge Trust®
The Bridge Trust® is a hybrid Asset Protection Trust (APT) that offers the simplicity of a domestic trust and the protection of a Foreign Asset Protection Trust (FAPT) when needed. In calm conditions, the client serves as the controlling trustee. If a threat arises, The Bridge Trust® becomes a fully foreign FAPT, offering the best of both worlds.
Concept #6: Full Step-by-Step Integration
By integrating the above concepts, you can effectively protect your real estate assets. Start by determining the net value of your real estate, decide how much risk you’re willing to pool, group your real estate accordingly, and create separate LLCs for each group. Next, create a multi-member holding company to own these LLCs, transfer ownership into the holding company, and add a final layer of protection by creating The Bridge Trust®. Lastly, ensure smooth integration with your existing estate plan.
Understanding these key concepts and integrating them effectively can provide you with confidence in your financial future and a robust shield for your real estate assets. Below are more advanced concepts to further increase protection.
Concept #7: Joint Ownership
While not always suitable, joint ownership can be another tool for protection. For example, tenants by entirety (TBE), a form of joint ownership for married couples in some U.S. states, can offer robust asset protection. If one spouse is sued, as long as the debt is not a joint debt or based on a joint activity, the entire property cannot be taken by creditors. This is because under TBE, both spouses are considered to own 100% of the property, so a creditor of only one spouse cannot claim their “share” of the property.
Concept #8: Homestead Exemptions
Many U.S. states offer Homestead Exemptions, which can protect a certain amount of home equity from creditors. The amount of protection varies widely by state. For example, in Texas and Florida, your entire homestead, no matter how much it’s worth, can be exempt from creditors (with certain acreage limitations). In contrast, some states offer only a modest amount of protection.
Concept #9: Irrevocable Trusts
Irrevocable trusts can provide another layer of asset protection. Once assets are transferred into an irrevocable trust, they are no longer legally considered yours, which can protect them from creditors. However, they can’t be easily removed or changed without the beneficiary’s permission.
Concept #10: Insurance
Insurance is another key tool for asset protection. It’s important to have comprehensive insurance on your properties to cover any potential losses. Also, consider umbrella insurance policies that cover a wide range of potential liability situations that exceed the limits of regular policies.