Asset Protection for Your Primary Residence
A solid asset protection strategy must be tailored around the specific asset to be protected. Liquid investments should be approached differently than tangible assets. Real estate should be treated differently than crypto. And most relevant to this post, not all property is the same: your primary residence follows a different set of rules than an investment property.
What Is a Primary Residence?
For most of you, determining your primary residence is easy. It’s where you live. But if you’re a snowbird, or you own multiple properties and are not regularly in one more than another, it’s going to come down to what state you are in.
In Nevada, like most states, your primary residence is the state you spend the most time in. California, intent is paramount, and there is no minimum time rule (probably so they can tax you even if all you ever did was dip your toe in the water at one of its beaches).
How Is a Primary Residence Different than an Investment Property for Asset Protection Purposes?
For an investment property, the go-to asset protection device is going to be an LLC. If the LLC owns the property, then it (generally) cannot be used to satisfy your personal debts. The LLC is different than you, and just like you aren’t responsible for your neighbor’s debts, your LLC is not responsible for yours. (There are exceptions, though!)
Your primary residence is different. Because having a creditor take your home is much more devastating than if they foreclose on a rental property, most states have enacted some built-in protections to make sure your debts don’t ever result in your homelessness.
These are called homestead protections.
Homestead Protections
A homestead protection, generally speaking, protects a set amount of equity in your home. That won’t stop the creditor from foreclosing on your home, but it will ensure you get paid before the creditor in the protected amount so you can use that as a down payment on a new home and therefore never be without a roof over your head.
New Jersey and Pennsylvania are the only states that do not provide any homestead protection. If you live in one of those two states, you’ll want to consider asset protection alternatives.
In Arkansas, Florida, Iowa, Kansas, South Dakota, Texas, and Washington D.C., there is no upper limit to the equity protected.
Most states lie somewhere in-between. Tennessee and Virginia only protect $5,000. Nevada protects $550,000. In California, the number depends on the county you live in.
You can look up your state here.
In many cases, the homestead protection is automatic. You don’t really have to do anything to get it. In some cases, you do have to file a document declaring your homestead, but even then in some cases you can file that at any time, even during foreclosure proceedings.
If you live in a state that provides more protection than the equity you have in your home, you are probably set. You don’t have to worry about losing your home.
But what if you have more equity than your state will protect? What are your options then?
Equity Stripping
There are two parts to this equation: the amount of homestead protection on the one side and the amount of equity you have in your home on the other. As long as the protection exceeds the equity, you’re golden.
If not, and you still want to take advantage of the homestead protection, there is only one side of the equation you have the power to change—the amount of equity in your home.
Equity stripping is the process by which you reduce the equity in your home to bring it down under the threshold of protection. If you take out home equity loan, invest that money somewhere where it is protected, and it is earning more than the interest it costs to access it, then not only are your assets working harder for you than they would if you left them in the home, but now they’re protected, too.
Another Option - Putting Your Home in an LLC
If equity stripping isn’t an option, either because you are adverse to the idea of taking out a home loan, or because you are in a state whose protections are so low that it wouldn’t be feasible (or possible), then another option is putting your home in an LLC.
The idea here is that you are converting your primary residence into an investment property, and then your LLC is going to rent it out to you, as the tenant.
If you do this, you will lose any built-in homestead protections you have because you are a renter, and the homestead protection won’t apply to you because you don’t own the home. It also will not protect the LLC because, all through the LLC is the homeowner, it does not reside in the home, so it is not a primary residence. (This, too, may vary state to state.)
Because you do lose the protections that are built-in, there is some risk. The protections an LLC offers are not automatic like they typically are with the homestead. You have to maintain your LLC and keep it separate from your individual financials.
That means you are going to draft a lease between you and the LLC. You are going to pay rent every month. The LLC is going to use that money for repairs and home maintenance. And it’s going to pay the mortgage, property taxes, etc. The LLC is going to file taxes every year. It’s going to have a set of books it has to keep. It’s going to maintain a registered agent in your state and make sure it is renewed every year. It is going to hold meetings and keep minutes on those meetings. In short, your LLC is going to operate like any other business.
And that’s the cost of doing business—doing business. If you put your home in an LLC, but you do not put the work in to maintain it and keep it separate, then you run the risk of losing that protection through a veil-piercing action.