The best asset protection advice under all circumstances: give it away! Creditors can’t take what you don’t own, but if you want to keep some ownership interest, some control or influence when summer weeks are allocated to family members for their enjoyment, consider setting up a limited liability company (“LLC”) to own the vacation home. Owners can retain management units of the LLC and give away the non-management units. In the event of injury by a guest or invitee, the party defendant will be the LLC and not the individual member.
Even if the vacation home is used solely by the family and not rented out, the vacation home should still be owned by a LLC because the LLC’s operating agreement can address how to deal with a member’s creditor who seeks an interest in the LLC or the member’s LLC’s units in satisfaction of an obligation. As an example, the family members of the LLC can agree in the LLC’s operating agreement that in the event an LLC member attempts to assign his or her membership interest to secure or liquidate a debt, the other members or the LLC have the right to purchase the membership interest on favorable terms, such as, in installments over a 10-year period, at a low rate of interest.
If a member’s ownership interest is seized by a creditor, the creditor customarily receives a “charging order,” which means the creditor doesn’t become a member of the LLC, can’t use the vacation home, can’t force its sale, and can’t force any distributions of income if the vacation home is rented out for any period of time.
The best of both worlds – asset protection and estate planning – for that vacation home is a qualified personal residence trust (“QPRT’). In this scenario, owners transfer their home into a grantor trust for the benefit of their children or other beneficiaries, retaining the right to live in the home rent-free for a period of time. The owners retain the right to control the home for the period, but thereafter must rent the home from the beneficiaries, who then own the home.
The gift tax effect is minimal, because the gift is the residual value to the beneficiaries (as an example, a gift by a 60 year old of a $1,000,000 vacation home to a QPRT with a ten-year term will result in an approximate 37% utilization of the present $2,000,000 credit against estate tax). The vacation residence, and all appreciation after the date of the gift, is excluded from the owner’s taxable estate, provided the owner survives the term of the QPRT.
The income tax consequences are beneficial to the owner: since the QPRT is a grantor trust, the owner retains the income tax benefits during the rent-free term, i.e., the owner deducts the real estate tax and interest on any mortgage payments made. Another benefit: these payments are not considered additional gifts to the beneficiaries, so there is no utilization of either the present $12,000 annual donee gift tax exclusion or the $1,000,000 lifetime gift tax exclusion.
There are many advantages in establishing a QPRT, and some disadvantages. When considering a QPRT, the estate tax advantages and disadvantages must be contrasted with the income tax consequences. From an asset protection perspective, since the residence isn’t owned by the party setting up the QPRT, only the rent-free term is subject to creditor attack – and we are unaware of any caselaw addressing this issue.
Please do not hesitate to contact us if you want to discuss the asset protection of, and/or estate planning for, the vacation home.