Many people like the idea of protecting their home from future creditors.

Over the years, we have provided our clients protection of their homes using something called a Personal Residence Trust. This type of trust is designed to protect a home from a person’s personal future creditors that may arise. One never knows how and when a creditor claim may arise. A claim may result from a totally unexpected auto accident or some other circumstance such as s slip and fall on your sidewalk or a dog attack. Sometimes insurance does not provide any or enough protection. After all, insurance companies are in business to make a profit, not pay claims, if they can avoid paying them. A creditor claim may not even be your direct fault, but it does not take much for a personal injury lawyer, a judge and jury to find a sliver of fault and enough causation to hold all manner of persons liable when a party is injured. Claims can also arise from contract claims, business relationships gone bad or even a tax lien. Leaving your home exposed to a personal injury claim is just going to make some personal injury lawyer richer at your expense. Leaving your home exposed is just going to transfer your wealth to the government to pay off any claims they may assert, if you could have protected it, but chose not to.

A Personal Residence Trust is a wide ranging term. Generally, it means a trust created to hold property containing restrictions to protect a home against possible losses and claims. Such trusts can be created to hold vacation homes and second homes. This kind of trust is designed so that the income from the trust, if any, is taxed to the client for whom we create the trust. In essence, the trust is ignored for tax purposes so that no tax issues are created and the tax benefits are preserved. There are many different formats and strategies which can be used for creating this type of trust, depending upon the particular circumstances of the case.

One popular technique is to provide in the PRT that our client’ children or other family members (or a LLC) succeed to ownership of the house after a certain number of years. The trust reserves to you the right to live there for a period of time-perhaps 10 or 20 years. In addition to strong asset protection advantages, a PRT, depending on the exact trust terms, may provide excellent estate tax benefits by freezing the value of the house at its current amount and removing it from your taxable estate. The period of years and the important terms can be modified or tailored to meet most circumstances. Even if taxes are not an issue, the asset protection aspects can be the primary focus.

At times, a reverse of this arrangement and strategy is used. For example, if the circumstances warrant, rather than reserving a right to live there for a period of years, the PRT can provide that the home belongs to the trust but can be leased back to you for a period of years. Although you would pay rent to the trust, the usual tax benefits would apply because of the grantor trust rules, as currently in place. At the end of the term of the lease, full ownership could be returned to you or passed to your children. It can go either way, depending upon your view of any future potential liability you may have.

These trusts also need to be structured to provide avoidance of property tax reassessment, where feasible. With the passage of Proposition 19 in California, these rules have become restrictive and limited.

As an additional asset protection strategy, the PRT or another entity such as an LLC owned by you and/or your family could be provided with an option to purchase or a right to exercise some other authority over the property within the trust. For example, assume your home is worth $1 million with a loan of $300,000. A Personal Residence Trust is created which grants the trust an option to purchase the property for the price of assuming the loan amount only, any time within the next 20 years. The option agreement is recorded. The option serves the same as a lien on the property. It serves as notice to any subsequent creditors that prior rights to the property exist (the recorded option), and at a price that is for significantly less than FMV. The equity in the home cannot be seized by a successful plaintiff, since the home itself is subject to the option to purchase for the $300,000 amount. Under this arrangement you can live in the house without restriction and subject only to whatever terms are provided in the option agreement. There are a number of issues which must be addressed in this type of strategy and you should always have legal counsel to help you navigate the laws. However, this illustration gives you an idea of the direction that planning can be taken. The more sophisticated the planning, often the more protection is obtained.