Don’t lose your home in a lawsuit
By David B. Mandell, JD, MBA

Doctors pay millions of dollars over their careers for medical malpractice insurance coverage and often thousands more to protect some of their assets, yet they still fail to protect their single largest asset — their home. Why is this?

Perhaps you believe your home is protected from creditors or you believe protecting the home means giving it away or incurring expensive legal costs. None of these is true.

You have choices in protecting your assets — some better than others. Let’s examine the less desirable alternatives first.

SUBSTANDARD SOLUTIONS

While the following solutions make sense under the right circumstances, none offers wealth accumulation in addition to the asset protection benefits. That’s why they are “substandard.”

1. State homestead law. Every state has some type of homestead protection. In most states, the amount of homestead that is protected from creditors is small, relative to the average home price. Only a few states (Florida, Texas, Kansas) have strong homestead protections.

In those states, homestead protection can be relied upon for asset protection in some circumstances, but the equity in the house is not “working for you.” The house will appreciate in value at the same rate whether you have 1 percent or 100 percent equity in the home.

2. Tenancy by the entirety. In a minority of states, you can file to title your home as Tenancy by the Entirety (T/E). Theoretically, only a creditor who has a claim against both you and your spouse can take the home if it is titled this way.

This can give a false sense of security for a few reasons:

First, there has been a case when a litigant successfully penetrated T/E and took a home from a couple because the couple had at least one joint creditor (it was a credit card with both of their names on it).

Second, if a creditor arises from real estate that is owned by T/E or a lawsuit is filed against you and your spouse because of an act of your children or tenants, you will both be named. In these cases, T/E will not provide any protection.

T/E could protect your home from a malpractice judgment, but the risk of having T/E penetrated and the fact that the equity in the real estate is still not “working for you” make this an undesirable alternative.

3. LLCs and FLPs. Limited Liability Companies (LLCs) and Family Limited Partnerships (FLPs) are solid asset-protection tools for most liquid assets, business equipment, and as the first part of an asset-protection plan for rental real estate.

LLCs and FLPs also offer income and estate tax-planning benefits. However, both of these benefits pale in comparison to the tax costs of putting a primary residence into an LLC or FLP.

Individuals who own homes are offered some unique tax benefits — most notably, the $250,000/$500,000 capital gain exemption. By owning the home within an LLC or a FLP, this tax benefit is lost after two years.

Further, you may find yourself owing tens of thousands of dollars per year in additional income taxes if the mortgage interest is negatively affected. Further, if you have any existing mortgages, their “due on transfer” clause will likely be triggered immediately.

4. Qualified Personal Residence Trusts (QPRTs). QPRTs can offer effective asset protection against lawsuits unrelated to the property itself. However, a QPRT requires you to transfer ownership of the home to the trust with no strings attached (over a term of typically 10 years).

THE DEBT SHIELD

Opposed to the substandard options above, the debt shield is typically the ideal way to shield the equity of a home or other real estate. Essentially, using a debt shield means getting a loan against the property’s equity and investing that equity into an asset protection entity or investment.

For many clients, this is counterintuitive because they want to pay down the mortgage as much as possible.

UNDERSTANDING REAL ESTATE

Before getting into how this is done, it’s necessary to understand two basic real estate premises:

• Equity vs. fair market value (FMV). Equity does not equal wealth. Equity is actually a cost.

Professional real estate investors call equity the “opportunity cost.” In other words, it is the amount of capital they have to invest to purchase the entire piece of real estate, with the rest coming from financing (debt). They try to minimize this as much as possible.

Consider the following example:

You purchase a home for $500,000. You make a down payment of $100,000 with a 15-year mortgage. After five years, the value of the home has increased to $700,000 and the remaining mortgage is $300,000. If you sell, you will net $300,000 pre-tax.

But if you get an interest-only mortgage and invest the $100,000 instead of making a down payment, you can come out ahead. $100,000, invested at 8 percent for five years grows to more than $147,000. Selling both the home and the investment at the end of five years nets $347,000 pre-tax.

Paying down the equity of the home does not increase wealth as much as investing in a better opportunity.

• Cost of capital vs. use of capital. Build equity in a project and then leverage the equity to take advantage of another opportunity.

Banks give one rate on deposits and lend money at a higher rate. Real estate investors borrow against the equity in their projects (at one rate) and invest in projects that have higher projected rates of return.

If you want to protect your home, keep control of the home, and build wealth, then you should seriously consider the debt shield strategy for your home. Let’s examine how this works for you now.

DEBT SHIELD

The concept behind the debt shield is to build wealth while protecting your home. The basic steps include:

1. Protect 100 percent of the home equity with a mortgage. Through either a refinancing or home equity loan, you pay off existing lenders and invest the proceeds into an asset-protected vehicle. This protects the home equity (since there is no longer any equity) against future claims via the mortgage (the security interest).

2. Invest the loan proceeds. The investment should be in an asset-protected investment or entity. The key to the debt-shield strategy is efficiently moving wealth from unprotected title to protected title. To reach this end, the loan proceeds must be invested in a strong asset-protection tool, such as life insurance and annuities.

Life insurance is the ideal investment for high net-worth and high income investors because:

• Life insurance policies offer guaranteed minimum returns. When you consider that the guaranteed minimum crediting rates may be even higher than your loan costs, it is obvious to see that the opportunity for wealth creation exists.

• They offer upside while protecting your downside.

• The growth life in a life insurance policy is tax-deferred. Withdrawals and policy loans from a life insurance policy can be taken tax-free.

• The cash values in life insurance can be accessed completely tax-free at any time. For tax-free access to the funds with no time restrictions, insurance is much more desirable than mutual funds.

For most physicians, the home is the family’s most important asset. If you would like to protect your home while building wealth without working any harder, you owe it to yourself to explore this type of debt shield strategy.

David B. Mandell, JD, MBA is an attorney, lecturer, and author of the books The Doctor’s Wealth Protection Guide and Wealth Protection, MD. He is also a co-founder of The Wealth Protection Alliance (WPA), a nationwide network of elite independent financial advisory firms whose goal is to help clients build and preserve their wealth. He can be contacted at 800-554-7233 or by e-mail info@wealthprotectionalliance.com.