ComplianceLegalAugust 15, 2019

Protecting house without a homestead exemption

In a state without a homestead exemption, or with an extremely small exemption, you may be able to shield your home from your creditors by arranging for someone else to have an ownership interest in it.

If your state does not have a homestead exemption, or has an extremely small exemption, the form in which you own the home may determine the extent to which your home will be protected from creditors. 

If you are married and your spouse is not likely to be liable on any judgments against you, your best ownership options are:

  • transferring ownership to the spouse with less legal exposure or
  • tenancy by the entirety

While there are other forms of ownership, they do not offer the same degree of protection from creditors. These are:

  • joint tenancy and
  • tenancy in common

If you live in a community property state, you will need to consider community property laws in determining the best form of property ownership.

Asset transfers to non-business-owner spouse can help elude creditors

When faced with a nonexistent or extremely limited homestead exemption, one way to keep your home from falling into the hands of your creditors is to transfer the ownership to your spouse. 

This presupposes that:

  • You are planning in advance, so the conveyance won't be found to be fraudulent and
  • Your spouse is not going to be liable to the same creditors (or different creditors.)

This strategy adds an extra layer of protection if the business creditors are able to reach the owner's personal assets outside the business, which is possible in certain circumstances, such as where the owner makes a personal guarantee of a business debt or personally commits a tort such as negligence.

However, the risks inherent outright transfer of ownership are usually not worth the benefits. In a divorce action, the other spouse will own all the assets at the time of the proceeding. While judges in divorce actions normally have the power to make an equitable division of property acquired during marriage regardless of whose name is on the property, separate individual ownership creates a strong presumption in making the ultimate allocation of property between the spouses. 

In addition, as the sole owner of the property, a spouse can sell and use the property at will, regardless of the wishes of the non-owning spouse. This can be particularly perilous in the case of a home or business property. Therefore, this strategy is not recommended, especially in light of all of the other strategies available to business owners.

Tenancy by the entirety can thwart creditors

Owning your home as "tenants by the entirety" may offer you the greatest protection if there is no homestead exemption is available. However, tenancy by the entirety is not available to all homeowners. 

In order to hold property as tenants by the entirety, four stringent conditions must be met:

  1. You must live in a state that still recognized this form of property ownership.
  2. The property must be your personal residence..
  3. You must be married to your "co-tenant." This form of ownership is only available to spouses.
  4. You must take title as tenants by the entirety at the same time and with the same deed.

In a tenancy by the entirety, neither spouse may voluntarily, or involuntarily, convey their interest in the home without the consent of the other. This rule places the home out of the reach of the creditors of one of the spouses. Where both spouses are jointly liable on a debt, this form of ownership offers no protection.

Tenancy by the entirety applies only to your personal residence; you can't use it for other real estate or for other types of assets. And, don't confuse tenancy by the entirety with joint tenancy, tenancy in common, orcommunity property. These forms of ownership do not offer the kind of protection as does tenancy by the entirety.

Because tenancy by the entirety is a creature of state law, in order to take advantage of it in a bankruptcy action, you must be able to use your state's exemptions. Even then, the exemption will be valuable only if both spouses do not file a joint bankruptcy and only if the filing spouse is solely liable for the debt resulting in the lien on the home.

States that permit tenancy by the entirety. The following states permit a husband and wife to own a home in the form of a tenancy by the entirety:

States Permitting Tenancy by the Entirety
Alaska Arkansas Delaware
D.C. Florida Hawaii
Illinois Indiana Kentucky
Maryland Massachusetts     Missouri
New Jersey New York North Carolina
Oklahoma Oregon Pennsylvania
Rhode Island     Tennessee Vermont
Virginia Wyoming  


Where both a husband and wife are actively involved in operating a business, caution must be exercised. This ownership form offers no protection for debts on which the couple is jointly liable. Thus, great efforts should be made to ensure that only one spouse guarantees the contracts of the business entity, if the business's creditor demands a personal guarantee. Note that other strategies can protect assets when spouses operate a business together, such as operating the business as an LLC or a corporation.)

Both spouses will be liable for an individual spouse's negligence if the business is a general partnership and both spouses are owners. Only tenancy by the entirety could protect the couple's home if no homestead exemption is available. Remember, the general partnership is a business form that should be avoided, precisely because of the tremendous exposure to liability that it involves.

Taking the property at the same time, with the same deed. Tenancy by the entirety usually requires that the married couple take their interest in the home through the same deed at the same time. Thus, a transfer by a husband of a half-interest in a home to his spouse cannot create a tenancy by the entirety.

To correctly convert property to this form, the sole owner must transfer, by deed, the entire interest in the property to himself and his spouse, so that they both take their interests at the same time and through the same deed. Have an attorney draft or review the deed to make sure it accomplishes your purposes.

If your homestead is already jointly owned with your spouse, converting it to tenancy by the entirety carries no additional risks. However, when you own your home as separate property and convey an interest to your spouse to take advantage of tenancy by the entirety, additional risks are created.

First, if you get divorced, you may well lose your home (or at least a one-half interest in it.) Thus, you should weigh the risk of loss of your to creditors against the risk of loss that may occur as a result of a divorce.

Moreover, if a bankruptcy action is filed by one spouse, the property will become part of the bankruptcy estate if the nonfiling spouse dies, or receives a final decree of divorce, within six months after the bankruptcy action is completed.

Community Property Offers No Protection from Creditors

When considering forms of home ownership from an asset exemption standpoint, the results are the worst when property is owned as community property. In that case, the creditors of one spouse can reach the entire value of the property, not just that spouse's portion.

Most people do not need to worry about the impact of community property laws, because these laws exist in only nine states. However, if you have ever lived in a community property state and later move out of it, your existing community property retains its character despite your change in residence.

In these nine states, property acquired by a married couple during marriage, other than through individual gift or inheritance, is presumed to be owned in community property, regardless of which spouse's name is on the title or other ownership document. What's more, property that was acquired before the marriage, or during the marriage by gift or inheritance, may be transformed into community property if it is mixed or "co-mingled" with other community property.

Community property states
Arizona Louisiana     Texas
California     Nevada     Washington
Idaho New Mexico     Wisconsin

Married couples who own property, such as a home or investments, in a community property state may want to consider converting the ownership to joint tenancy, at least where only one spouse will be incurring the majority of debts. This will shield half of the value of the property.

In order to opt-out of the community property law with respect to some or all of your property, both spouses must sign what is known as a "transmutation agreement." This document, which must be carefully drafted by an attorney, can transform your property ownership into whichever form you wish, and can be written to apply to your existing property as well as property you acquire in the future.

Any change in ownership here must be carefully considered. The community property ownership form was designed to accord equal property rights to spouses. Thus, planning here may involve giving up some of these rights, and the cost of doing this must be weighed against the benefits derived.

Joint Tenancy Doesn't Shield Assets from Creditors

Tenancy by the entirety can protect your personal residence from creditors, even if there is an insufficient homestead exemption in your state. However, this form of ownership is not available in every state and is only available to married couples. 

In contrast, joint tenancy is available to any combination of individuals, and not simply spouses. Moreover, the number of co-owners is not limited to two. Unfortunately, joint tenancy does not protect the property from creditors the way that tenancy by the entirety does.

As with a tenancy by the entirety, the owners usually must take equal interests, at the same time, and through the same deed or other instrument. This form also shares the following characteristic with tenancy by the entirety: If one owner dies, the survivor automatically, by operation of law, inherits the decedent's interest, regardless of any provisions in a will.

Unfortunately, joint tenancy does not shield your interest in property from creditors. A co-owner in joint tenancy, including a spouse, may freely sell his or her interest without the other's consent. Thus, it follows that creditors of one of the joint tenants can reach the debtor's interest in property owned in this form. Thus, joint tenancy does not offer the protection that is provided by tenancy by the entirety.

In the case of a married couple owning a home in joint tenancy, the creditors of one spouse could reach the half-interest owned by the debtor-spouse. Once this was done, the creditor could force a sale of the property, through a partition proceeding in state court, and use half of the proceeds (the debtor's share of the property) from the sale to pay off the debt. (This all assumes, of course, that a homestead exemption did not protect the property.)

Individuals who own property sometimes create a joint tenancy with another person, usually a close relative, in order to avoid probate court. Because joint tenancy includes a right of survivorship, this strategy works. Upon the death of one owner, the survivor automatically, by operation of law, acquires the decedent's interest. No probate court proceeding, and no deed or other transfer document, is necessary.

However, this strategy also can carry significant risks. For example, a widow with two children creates a joint tenancy in her home and bank account with one of the children for the purpose of avoiding probate court. A joint tenancy creates immediate rights in the other owner.

As a result, the one child could now force a sale of the home through a partition proceeding, pocket half of the sales proceeds, and possibly leave the mother homeless. In addition, this one child could withdraw 100 percent of the bank account, and the bank would have no liability, because any owner in joint tenancy has the right to use the property (even if they are only a half-owner).

Upon the death of the mother, the other child would be left with nothing. A verbal agreement (a common occurrence in these situations) among the three that the co-owner would share the inheritance with his or her sibling would usually be unenforceable.

Tenancy in common does not protect assets

Tenancy in common is another way in which you can hold a joint interest in property. From the standpoint of asset protection, tenancy in common provides no protection from the claims of creditors.

The main difference between tenancy in common and joint tenancy (or tenancy by the entirety) is the lack of a right of survivorship in a tenancy in common. If property is owned as tenancy in common and one of the parties dies, the decedent's interest passes to the beneficiary under the decedent's will, or to the closest heirs as directed by state statute. It does not pass to the surviving co-tenant.

Co-owners in a tenancy in common can hold unequal interests, and can take their ownership interests at different times and through different instruments. Often, if there is an attempt to create a joint tenancy that fails because the co-owners did not take possession at the same time and by the same legal document, the result will be a tenancy in common.

Revocable trust may protect a home

In a revocable living trust, the trustor (trust creator) can cancel or amend the trust at will, and the trustor is usually also the trustee and the beneficiary. Thus, the trustor still has complete control over the property. 

Although courts have ruled in tax cases that, after a transfer to a revocable living trust, the individual can exclude gain from the sale of a residence, as if it were still owned by the taxpayer personally, there is no guarantee that this same reasoning will extend to asset exemption cases.

"Estate by-pass" or "credit shelter trusts" can result in losing the asset exemption. There is one situation where transfers to a revocable living trust require special attention: transfers to an estate-tax-saving bypass or "credit-shelter" trust.

In this type of trust, a married couple transfers assets to the trust. While both are living, the trust is revocable. When the first spouse dies, that spouse's share of the trust assets flow into a new, irrevocable trust, under which those assets are managed for the surviving spouse. The survivor has limited powers with respect to the new trust's assets and therefore will escape estate tax on those assets when he or she eventually dies.

The surviving spouse may not be able to claim any exemptions in the assets in the irrevocable trust. The irrevocable trust will be recognized as a separate entity and, in fact, will pay its own income taxes, according to a separate schedule for trusts and estates. 

This is especially important to understand because, in many cases, an interest in a home, IRA or other exempt asset may have been contributed to the irrevocable trust. Exemptions would have continued to be available for these interests, had the transfers been outright to the surviving spouse. The bottom line: The exemptions will likely be lost.

However, protection may still exist, through a different strategy. Specifically, this type of trust can immunize trust assets from the claims of creditors through a spendthrift clause. While in certain circumstances this type of clause can be invalid, in the case of the irrevocable trust described here, it should be valid.

If you have a bypass trust and are unsure whether the trust contains an effective spendthrift clause, ask an estate planning attorney to review the document.

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