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Asset Protection and The Real Estate Paradox.

By Rob Lambert - Email Editor

Date : 24-May-2007

Dear Subscriber:

At least 5 times a week somebody asks me how to protect real estate. I often reply that even if they were to pay me a million dollars to build the fanciest Asset Protection Plan known to man, the protection affording real estate would be less than perfect. The reason: Real estate cannot be moved out of danger. If you get in trouble (meaning somebody obtains a judgment against you) it just isn't safe. The real estate will always be in the judicial district of some judge in the USA. This means that a judgment in any state will likely be enforceable against the property, no matter which state it is located in. (Remember the Full Faith and Credit Clause of the Constitution requires sister states to recognize each other's judgments).

Well, what can you do? We all know that real estate is often a great investment vehicle. It is a shame to forego real estate just because of the fear of some predator attacking it. Here are seven key rules of real estate.

Rule Number 1: Real Estate is NOT Forever.

Real estate can be a great way to make money; it is just not a great way to protect it. What I tell my clients is that cash and cash equivalents like stocks and bonds are very solidly protected when a Plan is done well in advance of any attack. This is because the liquidity can be moved out of harms way with the stroke of a pen. However, this is not true with real estate. So, to coordinate solid protection with a significant real estate portfolio, it requires a Plan to extract equity from the protected real estate. The normal ways are borrowing or selling. So, don't get too attached to your real estate; you may have to sell it (or borrow against it) if serious attack comes. Once you have extracted equity, thereby making your home or investment real estate an unattractive target, you can then protect the extracted equity. To make this work without having the act of protecting the equity be classified as a fraudulent conveyance, the Plan must be “old and cold.”

Rule Number 2: Divide and Conquer.

Never mix liability producing assets. If you own two apartment houses, do not have them owned by the same Limited Liability Company or Limited Partnership. Instead, have a separate entity for each property. I always tell my clients that they shouldn't buy any piece of real estate unless they can justify the cost of forming a separate entity for each piece.

Rule Number 3 and 4: Avoid the Phony Loan Scam, and Don't Give It Away.

I lump these together because they are the two simplistic techniques everybody thinks of when they own real estate and feel threatened. Suffice it to say, neither works. Uncle Fred's phony deed of trust against your property just doesn't pass the smell test. Most people don't even really pass the money or even pay the interest. It takes a judge about 5 minutes to undo this. Similarly, the “I gave it to my wife” Asset Protection Plan just doesn't work either; unless the gift was real, AND the gift is “old and cold” so that the statute of limitations on fraudulent conveyances has run. Bottom line: Don't do either because neither works.

Rule Number 5: Don't Count on your LLC or FLP.

Limited Liability Companies or Limited Partnerships (often called Family Limited Partnerships so that promoters can charge a few grand more for them) are great vehicles to hold real estate. They are often sold because they offer something called charging order protection (this means that a creditor of a partner or member cannot normally force a distribution of assets). Although I favor these entities, it is a major mistake to count on charging order protection. Too many people have abused it and judges are now routinely allowing creditors to seize the partnership or membership interest and thereby get to the underlying assets. It helps if the LLC or FLP has more than one member, and it is also wise to connect the LLC or FLP to a properly done Asset Protection Trust. (More on this in a later newsletter). In short, these are helpful entities and a good first step toward Asset Protection; however, they are not enough alone.

Rule Number 6: Keep Good Liability Insurance.

Asset Protection is never enough alone. It is a tool to discourage litigation and protect your wealth. It does not provide a defense if you are sued. Insurance does.

Rule Number 7: Personal Residences Don't Fit.

We have already devoted lots of ink to the tricks and traps of protecting personal residences. This is a big topic. In this newsletter, I just wanted to point out that I do not favor exotic techniques or foreign techniques to protect your home. In addition, including your home in some Asset Protection Plan can sometimes endanger the tax treatment of the residence and the deductibility of interest. More on this later. Finally, never forget the Homestead Exemption which can be helpful in many states. Sometimes extracting equity (or preparing to extract equity) with an equity line of credit (which doesn't need to be drawn down at inception) and preserving your homestead protection can make a home a small and unattractive target.

One interesting fact: In the USA we have 7% of the world's population, and 94% of the lawyers. No wonder this is the most litigious country in the world. This is also why you will never see effective tort reform from the government or judicial system. If you want protection, you will have to do it yourself, unfortunately.

I wish you a healthy and protected week.

Rob Lambert

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