Asset Protection

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If you own real property outside of your state of residence when you die, you will have to conduct an ancillary probate in that state to transfer title to the property to your beneficiaries.  In some states, like Texas, ancillary probate is a simple process of recording copies of the out of state probate in the state in which the real property is located.  In others, the process is more complicated and will require hiring an attorney in the state and prosecuting a court proceeding.

One way to avoid ancillary probate is to form a limited liability company (LLC) or limited partnership (LP) to own the out of state property.  If the client does this then he will no longer own real estate out of state.  Instead, he or she will own an interest in an entity that owns real estate in that state.  Accordingly, there is no longer the need to prosecute an ancillary probate.  The entity can be formed in the client’s state of residence, the state the property is located or some other jurisdiction.  It doesn’t matter.  Use of the LLC or LP also adds a layer of asset protection for the client.

Note that using an LLC or LP doesn’t mean the client will not owe property taxes or income taxes (if a rental property) in the state in which the property is located.

Texas has one of the most expansive homestead laws in the country.    Homestead designation protects the homeowner from creditors claims, other than certain taxes and loans secured with the homestead. This blog post will cover the types of Texas homesteads, and who benefits from homestead designation.

Types of Homesteads

There are two types of homesteads, urban and rural.  You have one or the other, not both.  An urban homestead is limited to ten acres and is located in a municipality served by police and fire protection with at least three municipal services provided, such as water, electricity and gas.   A rural homestead is any homestead that doesn’t meet the criteria for an urban homestead.  A family can have a rural homestead of up to 200 acres, a single person 100 acres.

Tex. Prop. Code Ann.  41.002

Who May Claim Homestead Protection

Family

A family may claim homestead protection.  A family is a head of household, and those bound by blood or marriage that are depend on the head of household for support.  This covers a spouse and minor children, but may include adult children in certain cases, such as an adult child living with a parent while attending college.

Single Adult

A single adult can claim homestead protection for an urban or rural homestead, but, in the case of a rural homestead, the homestead is limited to 100 acres instead of 200 acres.

Surviving Spouse

The deceased spouse’s homestead rights pass to the surviving spouse so long as the surviving spouse continues to occupy the homestead.

Surviving Minor Children

The surviving minor children of deceased parents, have the right to claim their deceased parents’ homestead for the duration of their minority.  This right pertains even if the minor children were not living in the home at the death of the parents.

The special occupancy rights of the surviving spouse or surviving minor children persist unless abandoned.  The burden of proving abandonment is on the party seeking to terminate the homestead rights.

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Asset protection planning is complicated.  While estate and trust law changes very slowly, debt/creditor law can be quite dynamic in comparison.  Good planning needs to take the long term perspective, and avoid a cookie cutter appearance.

Based on my experience, there are a few general rules I follow.

  1.   Pigs get fat, and hogs get slaughtered.  If there are any potential liabilities on the horizon, do not put assets in excess of those potential liabilities into an asset protection structure.
  2.   Stay Home.  A judge in the state of your residence is not going to like (i) an offshore arrangement, (ii) a nonresident domestic asset protection trust or (iii) an LLC or limited partnership organized under the laws of another state.  There is a lot you can do under the laws of the state of residence.  Focus there first.
  3.   Control.  There is an inverse relationship between the amount of control you retain and the effectiveness of your  planning.  Trust planning is most protective with an independent trustee with unfettered discretion over distributions.   Cultivate a close relationship with a financial institution with a trust company.  A corporate fiduciary with whom you have a close relationship can be a significant asset when undertaking asset protection planning.
  4. Business or Estate Planning Purposes.  The best asset protection planning is planning that has the primary objective of meeting a business or estate planning purpose, with the ancillary benefit of asset protection.

If you follow these general rules, then you castle will have a solid foundation rather than a foundation of sand waiting to be blown away in a storm.

 

In my last blog post I noted that it might be a good time to reconsider discount planning with family limited partnerships (FLP).  That thought has only increased over the last few weeks as the chances for tax reform dwindle.  Indeed, while political predictions are a fools game, we now have to seriously consider a move left in 2020 and, at best, a stalemate until then.  The move left could endanger discount planning again, so the next few years might be a window to make use of this kind of planning.

While this planning can involve transfers downstream via dynastic trusts, it can also involve leveraging the lifetime exemption using FLP discounts via gifts to spousal lifetime access trusts (SLATs).  A SLAT is an irrevocable trust benefiting the spouse, and then descendants.   Each spouse can create their own SLAT, provided they avoid the reciprocal trust doctrine, and the marital estate can still have use of the gifted assets during their joint lives.  In December of 2012, with the risk of the lifetime exemption being reduced, many, many SLATs were implemented.

SLATs raise a number of issues to work through, in addition to the aforementioned reciprocal trust doctrine, but, in the right circumstances, they over an elegant solution that offers a bit of a have your cake and eat it too flair.

Given my experience with my mom, it is not surprising that the first topic I want to cover is who should be named trustee.  The truth is that there is no single answer to that question, because trusts (which are simply vehicles where beneficiary ownership is separated from legal ownership) are created for many different reasons.  The trustee, who holds legal title and owes the beneficiary a fiduciary duty to manage the assets held in the trust for the beneficiary’s benefit, can be an individual, an institution or even the beneficiary, depending on the purpose of the trust.

Spendthrift Protection

Many trusts are created to take advantage of spendthrift protection.  In Texas, like most states, a trust created for a beneficiary other than the grantor (the person establishing the trust) provides some level of protection from the creditors (called spendthirft protection) of that beneficiary if someone other than the beneficiary is trustee or, if the beneficiary is trustee, the trustee is limited in making distributions to an “ascertainable standard.”  The typical ascertainable standard is the “health, education, maintenance and support” of the beneficiary.  Words matter here, and Texas is very strict.  In Lehman v. United States, 448 F. 2d 1318(5th Cir. 1971) the court held that use of the word “comfort” along with support and maintenance was enough to negate an ascertainable standard.

Estate and Gift Taxes

Ascertainable standard is very important for estate and gift taxes as well.  The IRS looks to state law to determine if an ascertainable standard exits, and, if it does, then it is possible for trust property to pass from one beneficiary to another without estate or gift tax consequences.  So, for example, if dad creates a trust for his son for the son’s life and then to the son’s descendants  , the trust property will escape estate taxes at the son’s death.  Of course, the initial funding of the trust by dad is a gift, but that is a topic for another day.

Often trusts are created for estate tax savings where spendthrift protection is a secondary consideration.

May or Shall

As I said words matter here, and the use of the words “may” or “shall” before the distribution standard impacts the creditor protection significantly.  Use of the word “may” means the distribution is discretionary.  Use of the word “shall” means the distribution is mandatory.  Of course, if the distribution is mandatory, it provides less creditor protection than if the distribution is discretionary.

Who is the Trustee

Finally, who the grantor names as trustee impacts the level of creditor protection.  A trust naming the beneficiary as trustee with an ascertainable distribution standard will provide a modicum of creditor protection.  A trust naming an independent person as trustee with a wholly discretionary distribution standard provides the highest level of creditor protection.   Care should also be taken in selection of successor trustees or successor trustee selection methods.

Trusts are not one size fits all.  You essentially start with a clean canvas.  It is up to the attorney to carefully discuss with the client all options and objectives and inform the client about the benefits and risks of each option along the decision tree.