How To Protect Your Home Equity From Liability

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Source / Disclosures

Disclosures: Bhatia and Mandell do not report any relevant financial disclosures.


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With personal retirement and investment accounts, the family home and its equity are often a physician’s most valuable asset.

Additionally, with the real estate market heated up in 2021, many physicians have seen their homes’ value increase dramatically, potentially putting even more equity in a vulnerable position.

Beyond its purely financial value, the family home also has great psychological value. In fact, David finds that most clients who engage in asset protection planning start by asking how they can protect their home. This is why we have decided to devote a section of this column to this subject.

Internal risk insurance

Sanjeev Bhatia, MD

Sanjeev Bhatia

David B. Mandell, JD, MBA

David B. Mandell

Internal risks are those that threaten the house due to the potential liability created by the house itself. This would include injuries to the property, such as slips or falls; swimming pool accidents; and liability for guests who drink at home and then drive (including guests of teenagers or college-aged children). Although rare, these risks can be significant in terms of potential liability.

The best way to protect the home and other assets from insider risks is to use insurance – especially homeowners and umbrella coverage. Home insurance is often required by lenders if there is a mortgage on the property; however, the amounts of coverage required are a floor and may not be sufficient for sufficient protection. Umbrella cover should also be considered essential, although it is not required by lenders. Given its low cost (millions of dollars in coverage can often be obtained for less than $ 1,000 per year), umbrella coverage is an effective protector of assets. Make sure that the terms of the framework insurance policy align with the home and auto insurance policies, so that there are no gaps in coverage.

Tools protect the house from external risks

Risks outside the home are potential claims against the owner – either the doctor or the spouse – for whatever reason. These types of risks are generally more common and priority for physicians and include potential claims for medical malpractice, automobile accidents and contractual liability or claims arising from personal guarantees. To protect the home and its equity from such potential claims, doctors have several tools available, including state exemptions, condominiums, and legal tools.

State Homestead Law

As noted in our previous columns, every state has a Homestead Protection Act which states that a certain amount of home equity is exempt from lawsuits and claims by creditors. In a few states, homestead laws protect unlimited value, although there may be geographic limitations, in states like Texas and Florida, for example. In states where homestead law protects unlimited value, doctors only need to confirm that their home qualifies and that the equity in their property is fully protected.

In most states, however, including Illinois, New York, and California, the value that homestead rules protect is low compared to the value of real estate. On average, the state’s family property laws protect about $ 30,000 to $ 50,000 in equity, typically a small fraction of the value of most doctors’ homes. In these states, additional protection options should be considered.

Rental in full

Often described as a “quasi-exempt” asset class, whole rental (TBE) is a form of joint ownership for married couples available in several states. Essentially, in states that protect real estate well with TBE, the house will not be subject to any claims against a spouse.

This can be invaluable for a married couple when one spouse has significant exposure (i.e. a doctor) and the other does not. Certain limitations are inherent in the TBE, notably the absence of protection for common risks or for unmarried persons.

Asset protection trusts

There are many types of trusts that can be useful in asset protection planning. When protecting a home, the two most popular are a National Asset Protection Trust (DAPT) in states that allow them and a Qualified Personal Residence Trust (QPRT), available in all states.

About 20 states, including Ohio, Connecticut, and Nevada, have passed DAPT legislation. In these states, a physician can establish and be the beneficiary of an irrevocable trust. When there is no problem with the lawsuit, the doctor can access the trust assets as a beneficiary, but if the doctor has any plaintiffs to sue, the trust is written in such a way that the trustee cannot not make distributions to the doctor because they are “under duress”.

Because there are no distributions anyway, a DAPT can protect the house well. Additionally, the DAPT can be set up as a grantor trust, meaning that the trust is treated for tax purposes as if it belongs to the doctors.

In all states, doctors can use a QPRT to protect their homes. While this is effective for both asset protection and estate planning purposes, it comes at a significant cost. You no longer own your home. In fact, when the number of years is up (the typical range for a QPRT is 5 to 20 years), you have to pay rent to the trust just to live in your house. In addition, houses with mortgages on them present tax difficulties.

For these reasons, physicians should use experienced legal advisers when implementing DAPTs and QPRTs.

Debt shields

The debt shield can be an effective way to protect home equity. Essentially, using a debt shield means getting a home equity loan. For many clients, this is counterintuitive because they want to pay off the mortgage as much as possible, a process that can have emotional appeal. However, for asset protection purposes, this is the exact opposite of what one should do in states where homestead, TBE, and trusts are not viable options.

For some doctors, using a debt shield does not mean taking out a new loan for their home. Rather, it may mean not following a mortgage repayment strategy faster than necessary. With respect to debt protections, when deciding whether or to what extent to pay off a mortgage, the physician should ask himself the following questions: Could the funds be invested in another, better protected asset? Could the funds be invested in another better performing asset? When it comes to getting a new loan, the analysis is the same.

From an asset protection standpoint, the transaction is straightforward. Use the Debt Shield to move equity from the vulnerable asset (the house) to one that is better protected. From an economic point of view, the decision-making process is also simple. Determine whether the cost of transferring equity (the after-tax interest cost) is greater or less than the return that the asset ultimately purchased with the loan proceeds can generate, as well as the “security” of the asset in which you invest.

Conclusion

For most physicians, there is no asset more financially and psychologically important than the family home. Some states provide excellent homestead protection, but most states provide inadequate shield. Potential options include TBEs, trusts, or some type of debt protection strategy.

Reference:

Wealth Planning for the Modern Physician: From Residence to Retirement is available for free in print or as an electronic download by texting HEALIO at 844-418-1212 or at www.ojmbookstore.com. Enter code HEALIO at checkout.

For more information:

Sanjeev Bhatia, MD, is a sports medicine orthopedic surgeon at Northwestern Medicine in Warrenville, Illinois. He can be contacted by email: [email protected]

David B. Mandell, JD, MBA, is a lawyer and founder of the wealth management company OJM Group, www.ojmgroup.com. He can be reached at [email protected] or (877) 656-4362. You should seek professional tax and legal advice before implementing any strategy discussed here.



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