No asset is more important to shield from creditor claims than the house we live in. For most of us, the house represents the bulk of our fortune. It may also have great sentimental value.
The personal residence trust is the most commonly used structure to protect a home. This is a structure that is inexpensive to set up, simple, and exceptionally effective. Over the course of our careers we have established hundreds of these trusts for our clients. They have never failed to achieve their desired objective. Let us take a look at how these trusts work.
A personal residence trust is an irrevocable trust. The word "irrevocable" scares many people. None of us want to do anything that is irrevocable, especially when we are talking about our most significant asset.
Fortunately, irrevocable means that no one (like a plaintiff or a creditor) would be able to force you to revoke the trust. If properly drafted, you will be able to do so. For example, under California law there is an easy procedure to revoke an irrevocable trust that just requires the trustee of the trust and the beneficiary to sign a simple document. We can also appoint a trust protector who will have the power to revoke the trust, make changes to the trust document and replace the trustee.
Because the trust is irrevocable, the assets owned by the trust are not owned by you. At least not in the legal, technical sense. The trust now owns your home. Because you no longer hold legal title to the house you live in, it is not an asset that your creditor can reach. Your legal relationship with the house you live in becomes the same as your legal relationship to the Transamerica building in San Francisco. It is not your asset, and when you get sued, your creditor cannot attach either one.
The residence trust allows you to continue living in the house, for the rest of your life. You should pay rent to live in the house (you no longer own it). Your children or other family members would be named as the beneficiaries on death. TIn many ways this structure is very similar to your living trust.
There are no income tax consequences on the transfer of the house into the residence trust. There are no property tax consequences and no property tax reassessment. Your bank cannot accelerate the mortgage (there is a federal statute that prevents the bank from doing anything with your mortgage when the ownership of the house is transferred to a trust).
Because the trustee of the trust will be a person you appoint (usually a friend or family member, but never you), you will retain the ability to sell the house or to refinance the house. Additional flexibility can be built into the trust to accommodate your specific needs.
The trust is not subject to any annual fees or filing requirements. Once it is done it is done.
To summarize, the residence trust is an inexpensive, easy to establish structure that allows you to continue living in your house, allows you to retain control over your house, but at the same time makes it unreachable to creditors (which has been tested in practice time and time again). It is no wonder that these trusts are our favorite asset protection technique for a personal residence.
Who will you appoint as the trustee or the protector of your trust? It should not be you or your spouse. It should be someone you trust.
Here are the most commonly used structures in asset protection. Click each to learn more.