Challenges of Protecting Real Estate
Real estate presents a significant challenge in asset protection because it cannot be easily relocated or hidden. Unlike liquid assets or movable property, which can be transferred to different jurisdictions, real estate remains fixed in its location. This makes it an obvious and accessible target for creditors seeking to attach liability. The location and ownership of real estate are usually publicly documented. These risks necessitate careful planning in order to safeguard real estate investments effectively. This article explores methods available to protect real estate, including homestead exemptions, equity stripping and the use of offshore trusts and LLCs.
Homestead Exemptions (US Real Estate)
Homestead exemption laws are designed to safeguard a portion of a homeowner’s equity from creditors in the event of a lawsuit. These laws vary by state, but generally allow homeowners to declare a certain amount of the value in their primary residence as exempt from creditors’ claims. This protection is valuable for preserving housing security for individuals. However, when these exemptions are unavailable or insufficient, alternate strategies become necessary.
Equity Stripping
This strategy involves borrowing against real estate to reduce its equity, making it less attractive to creditors. By doing so, the equity is converted into cash, subsequently opening up more options to protect the real estate. The borrowed funds can be deposited into an offshore trust bank account that earns interest and can be used to pay the lender’s fees. This tactic reduces the value of the real estate, making it a less attractive target for creditors. Additionally, the presence of a significant mortgage complicates a creditor’s ability to seize and sell the real estate, as the lender has a debt secured against the title which must be paid first. When done correctly, equity stripping is a highly effective way to protect real estate assets, but is a tactic that requires careful planning and the involvement of appropriately qualified and experienced professionals.
Ownership through Trust/LLC Structure
If equity stripping is not available or cost-effective, ownership of real estate can be transferred to an offshore trust or LLC structure. Depending on where the real estate is situated, a corporation, limited company or international business company may be preferable to an LLC.
Deciding whether to hold real estate directly within a trust or through an LLC owned by a trust involves several key considerations detailed below.
Direct Trust Ownership
While a trustee can accept real estate to be held at trust level, there are some important considerations to take into account:
Holding a primary residence directly in a trust can preserve certain tax and statutory entitlements that might be lost if an underlying LLC is used;
The trustee as the direct owner of the real estate is responsible for all home ownership laws in the jurisdiction where the real estate is based;
The trustee is responsible for maintaining insurances and making sure the property is well kept, even if they are based offshore and situated far from the property;
All rent collected on the real estate would need to be paid to a bank account owned by the trust unless a specific agreement to the contrary is in place;
If a creditor is successful in obtaining a judgment for a liability connected to the real estate and the claim exceeds the value of the real estate, the creditor may pursue other assets owned directly by the trust. This will be immaterial where the sole asset of the trust is the real estate; and
The trustee will generally require additional indemnities to hold the real estate at trust level, given the additional obligations, risks and potential liabilities involved.
Underlying LLC Ownership
Settlors may choose to have a trust holding a 100% membership interest in an underlying LLC which in turn owns the real estate.
Having real estate owned by an underlying LLC has some major asset protection benefits. Ideally, the LLC will hold a single real estate property and no other assets and if multiple properties are owned through this structure, each should be held in its own LLC. The benefits of this approach include the following:
Flexible Management: Use of the LLC allows for more flexible management of the real estate and its income. The LLC can have its own manager who controls the real estate and income. This can be the settlor, or a person or company that has the necessary skills to manage the LLC and the property;
Separate Bank Accounts: the LLC can have its own bank account, separate from the trust to receive any proceeds from the real estate such as rent, and to pay for any of its expenses;
Limited Liability: if a creditor is successful in obtaining a judgment against the LLC, it is limited to the assets held within the LLC. The other trust assets held outside of the LLC will remain out of reach;
Management Removal: the member of the LLC (the trustee of the trust which owns it) typically has powers to remove the manager of the LLC, for example, if they are under duress from a local court. In the case of a Cook Islands or Nevis LLC, the trustee can appoint a corporate manager outside of the jurisdiction of the Court to act in the role of manager while the event of duress persists;
Limited Remedies: even if a creditor is successful in obtaining a favourable judgment, the sole remedy available against an LLC in Nevis and the Cook Islands is a charging order. A charging order allows a creditor to collect a debt from a member of an LLC by redirecting any distributions that would have been paid to a member to the creditor, but it cannot attach to assets owned by the LLC unless and until they are distributed to the member; and
Duration Limits: in accordance with Section 45 (12) of the Cook Islands Limited Liability Companies Act 2008, a creditor’s charging order against a Cook Islands LLC is limited to a non-renewable term of 5 years. Similarly, Section 60 (15) of the Nevis Limited Liability Company Ordinance 2017, states that a charging order against a Nevis LLC is also non-renewable, with a duration limited to 3 years.
Transferring Real Estate
After determining the best structure with your asset protection advisor, the next step is to transfer ownership of the real estate into that structure. Generally, two requirements must be met to bring the asset under the protection of a trust:
Transfer of Legal Title to the Asset: in the case of US real estate, this is typically completed by a Grant Deed or Quitclaim Deed; and
Acceptance by the Trustee: a Deed of Gift can be used to formalize the trustee’s acceptance of the real estate. Where the real estate is to be held by an underlying LLC the trustee will record the real estate as having been gifted first to the trust and then transferred immediately afterwards to the LLC as a capital contribution.
If you are looking to transfer real estate into a trust or company structure, please let your Southpac contact know at the earliest opportunity so that they can work with you to complete the transaction.
Conclusion
Real estate asset protection requires a nuanced and strategic approach due to the challenges associated with the inherent immobility of real estate. While homestead exemptions provide a valuable layer of protection for many US homeowners, they are not always sufficient and cannot protect investment properties. Equity stripping offers a practical method to diminish the attractiveness of real estate to creditors by reducing its equity. Holding real estate in a trust or an LLC owned by a trust can offer significant protective benefits. Trusts can preserve tax and statutory entitlements for primary residences, while LLCs provide flexible management options and limit a creditor’s access to other trust assets. Ultimately, the choice between these strategies should be made in consultation with relevant professionals to ensure the method aligns with each person’s needs and circumstances,
