Protecting a Home from Creditors in Arizona
1. How does the Homestead Exemption protect a personal residence?
Arizona law provides a homestead exemption to any person who owns and occupies a personal residence in Arizona. This statutory exemption protects up to $400,000 of equity from creditors with some exceptions, including a mortgage, mechanic’s lien, and child support. The homestead exemption is intended to prevent the attachment or forced sale of a personal residence to satisfy judgment creditors. In Arizona the exemption is automatic, which means that no special action is required to benefit from it, although a homestead declaration may be recorded if you have more than one eligible property.
The $400,000 amount adjusts annually for inflation.
2. Does a Revocable Living Trust provide any additional protection?
No. A living trust does not provide any additional protection from creditors above and beyond the homestead exemption. The general rule is that a creditor can seize any trust asset that its original owner could freely remove from the trust. The trustor of a revocable living trust usually has full access to its assets, and thus, so will a judgment creditor. A personal residence owned and occupied by a judgment debtor will be protected to the extent the homestead exemption is available, but nothing further. Other properties held by the judgment debtor, such as rental homes, would be available to satisfy creditor claims whether titled in a revocable living trust or not.
3. What about gifting the personal residence to a spouse or child?
While gifting an asset outright to a spouse or other relative would clearly be fraudulent if a claim is known or reasonably foreseeable, it would also be foolish when no claim is imminent. If you gift an asset to your spouse, and then later divorces you, your ex-spouse keeps the asset and you get nothing. Likewise, your other relative would have no obligation to gift an asset back to you, or use the asset for your benefit, when you might want it back in the future. Even the act of your spouse or relative gifting an asset back to you may serve as evidence the initial gift was actually made to hinder or defraud a potential creditor.
A gifted asset is also exposed to creditor claims against the spouse or relative. For example, if your spouse is at fault in an auto accident, the asset you were trying to protect would be exposed to a potential new claim outside your control. Also consider the possibility that your relative might later get divorced and the relative's ex-spouse becomes entitled to one-half of an asset that was originally yours.
The better approach is to rely on liability insurance, LLCs, and irrevocable trusts to protect assets. Even an irrevocable trust with spousal access provisions may be drafted to define your spouse as the person you are married to and not necessarily the person you were married to at the time the trust was established. Similarly, an irrevocable trust for your children may be drafted to protect trust assets from creditors and ex-spouses of the children.
4. What if the residence is transferred to a Limited Liability Company?
This strategy does not work because an LLC must have a legitimate business purpose. A business purpose would include providing a service, product, or usable space to an unrelated person or company. Although placing a rental property into a LLC is good planning, your personal residence does not have a business purpose. Other reasons you should not transfer your personal residence into a LLC are (1) loss of exclusion of taxable gain upon sale of a personal residence, (2) loss of mortgage debt interest deduction, (3) loss of homestead exemption, and (4) possible increase in property taxes.
5. What about transferring the residence to an irrevocable Asset Protection Trust?
The irrevocable Arizona-based hybrid asset protection trust is an excellent option for protecting a personal residence with more than $400,000 of equity; provided, however, it is drafted as a grantor trust for income tax purposes. Although Arizona law does not permit self-settled asset protection trusts, an Arizona homeowner may still obtain the desired creditor protection by establishing the trust in Arizona, excluding the homeowner as an eligible trust beneficiary, and relying on spendthrift provisions to protect the trust assets from creditors of the eligible beneficiaries. This approach is referred to as a hybrid asset protection trust because it may be drafted to include a provision giving an independent person or company called a trust protector the power to move the trust to another state or country that permits self-settled asset protection trusts. This change of governing law might permit the trust protector to add the homeowner as an eligible trust beneficiary.
6. So what is the best option for protecting a primary residence?
In general, a homeowner is best protected by keeping home equity very low. This strategy may work very effectively, especially when combined with adequate homeowner’s liability insurance. Of course, the best option of all – from an asset protection standpoint at least – is to rent!
About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.
Arizona law provides a homestead exemption to any person who owns and occupies a personal residence in Arizona. This statutory exemption protects up to $400,000 of equity from creditors with some exceptions, including a mortgage, mechanic’s lien, and child support. The homestead exemption is intended to prevent the attachment or forced sale of a personal residence to satisfy judgment creditors. In Arizona the exemption is automatic, which means that no special action is required to benefit from it, although a homestead declaration may be recorded if you have more than one eligible property.
The $400,000 amount adjusts annually for inflation.
2. Does a Revocable Living Trust provide any additional protection?
No. A living trust does not provide any additional protection from creditors above and beyond the homestead exemption. The general rule is that a creditor can seize any trust asset that its original owner could freely remove from the trust. The trustor of a revocable living trust usually has full access to its assets, and thus, so will a judgment creditor. A personal residence owned and occupied by a judgment debtor will be protected to the extent the homestead exemption is available, but nothing further. Other properties held by the judgment debtor, such as rental homes, would be available to satisfy creditor claims whether titled in a revocable living trust or not.
3. What about gifting the personal residence to a spouse or child?
While gifting an asset outright to a spouse or other relative would clearly be fraudulent if a claim is known or reasonably foreseeable, it would also be foolish when no claim is imminent. If you gift an asset to your spouse, and then later divorces you, your ex-spouse keeps the asset and you get nothing. Likewise, your other relative would have no obligation to gift an asset back to you, or use the asset for your benefit, when you might want it back in the future. Even the act of your spouse or relative gifting an asset back to you may serve as evidence the initial gift was actually made to hinder or defraud a potential creditor.
A gifted asset is also exposed to creditor claims against the spouse or relative. For example, if your spouse is at fault in an auto accident, the asset you were trying to protect would be exposed to a potential new claim outside your control. Also consider the possibility that your relative might later get divorced and the relative's ex-spouse becomes entitled to one-half of an asset that was originally yours.
The better approach is to rely on liability insurance, LLCs, and irrevocable trusts to protect assets. Even an irrevocable trust with spousal access provisions may be drafted to define your spouse as the person you are married to and not necessarily the person you were married to at the time the trust was established. Similarly, an irrevocable trust for your children may be drafted to protect trust assets from creditors and ex-spouses of the children.
4. What if the residence is transferred to a Limited Liability Company?
This strategy does not work because an LLC must have a legitimate business purpose. A business purpose would include providing a service, product, or usable space to an unrelated person or company. Although placing a rental property into a LLC is good planning, your personal residence does not have a business purpose. Other reasons you should not transfer your personal residence into a LLC are (1) loss of exclusion of taxable gain upon sale of a personal residence, (2) loss of mortgage debt interest deduction, (3) loss of homestead exemption, and (4) possible increase in property taxes.
5. What about transferring the residence to an irrevocable Asset Protection Trust?
The irrevocable Arizona-based hybrid asset protection trust is an excellent option for protecting a personal residence with more than $400,000 of equity; provided, however, it is drafted as a grantor trust for income tax purposes. Although Arizona law does not permit self-settled asset protection trusts, an Arizona homeowner may still obtain the desired creditor protection by establishing the trust in Arizona, excluding the homeowner as an eligible trust beneficiary, and relying on spendthrift provisions to protect the trust assets from creditors of the eligible beneficiaries. This approach is referred to as a hybrid asset protection trust because it may be drafted to include a provision giving an independent person or company called a trust protector the power to move the trust to another state or country that permits self-settled asset protection trusts. This change of governing law might permit the trust protector to add the homeowner as an eligible trust beneficiary.
6. So what is the best option for protecting a primary residence?
In general, a homeowner is best protected by keeping home equity very low. This strategy may work very effectively, especially when combined with adequate homeowner’s liability insurance. Of course, the best option of all – from an asset protection standpoint at least – is to rent!
About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.