In a volatile economic climate, such as the current economic downturn, there is a significant increase in litigation cases and bankruptcy filings. When economic times flourish, people focus on acquiring assets and doing “deals”. During slower times, people may look for an opportunity to protect their assets from potential creditors’ claims. There are planning tools – entity selection, separation of personal and business assets, homestead exemption, adequate insurance, retirement account funding and gifting – that may protect your assets.
Choice of entity is vital for asset protection. Under a limited liability company or partnership, a judgment creditor can obtain a court order to attach just the membership interest of that member or that partner as the exclusive remedy to pay an outstanding judgment. The judgment creditor only has the rights of an assignee. The other member’s interests are protected. Single member LLC may not have this protection. Under either a partnership agreement or limited liability partnership, attaching the partner’s transferable interest is the exclusive remedy.
A court may appoint a receiver for the partner’s share of the distribution or order foreclosure of a transferable interest. The creditor will have no vote or participation in the management and they will not receive information regarding the business or the right to review books and records. The manager of a LLC or the general partner of a limited partnership continues to determine when distributions are made or the general partner or manager’s salary. This applies to general partners of a limited partnership, but not to a manager of a LLC.
Generally, always separate business and investment activities as well as personal assets from business assets. Avoid having multiple properties or businesses in the same entity as this may allow a creditor access to assets. Make sure to follow formalities so that your entity or entities are in good standing so creditor cannot “pierce” the “veil” of protection of the entity.
There is a $150,000 homestead exemption for a personal residence. Married couples can only claim one homestead exemption. Judgments will become a lien on real property for five years except for the homestead property, of which up to $150,000 will be unencumbered. A consensual lien such as a mortgage or deed of trust, a mechanics lien, or a lien for spousal maintenance/child support will still attach to the property.
The homestead exemption continues after a sale for eighteen months or until the proceeds are reinvested in a new homestead property. It also continues if the property is transferred to a revocable trust. No recording of the homestead is required.
It is preferred to limit equity in homestead property to less than $150,000. One option is a “Qualified Personal Residence Trust”. The party has the rent free use of the property for a period of time and the remaining interest is gifted. The split interest should have diminished value to creditors.
Another option is to borrow against the property with a home equity credit line and contribute proceeds to family limited liability company or family limited partnership for investment purposes and start a gifting program.
Other Asset Protection Tools
Because Arizona is a community property state, review how title to property is held as the community is responsible for community debts. If both spouses sign a personal guaranty, the spouses’ community property will be collectible by the judgment creditor in whose favor the guaranty was executed.
A gifting program may protect your assets. Always consider fraudulent transfer laws so that property is not inadvertently available to creditors. Gifts in irrevocable trusts may protect property from creditors while gifts or transfers in trust for spouse can’t protect spouse from community debt.
Maximize contributions to qualified retirement plans such as IRAs and 401(k) plans and consider funding Section 529 education savings plan accounts. Maintain adequate levels of liability insurance to further protect your assets.
It is important to start planning before problems occur to maximize the benefits of asset protection.