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Putting Personal Residences into an FLP or FLLC: A No-No

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Published: 09Oct2010
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The question of whether or not a personal family residence should be placed into a Family Limited Partnership ("FLP") or Family Limited Liability Company ("FLLC") frequently is a topic for discussion. The impetus for such a decision is based on the theory that the FLP or FLLC affords the owner a degree of asset protection against personal liability because a creditor is allegedly limited to a Charging Order Remedy when trying to get at the assets inside the FLP or FLLC. A Charging Order limits the creditor to a distribution right rather than the ability to seize the assets themselves within the FLP or FLLC. Whether or not the Charging Order Remedy really effectively precludes a creditor from getting to the assets of the FLP or FLLC is a questions which I have addressed in other articles. In any case, a creditor does normally have a more difficult time getting to assets that are inside an FLP or an FLLC than if they are held in the owner's individual name.

However, it wouldn't appear that placing a personal residence into an FLP or FLLC will really work. In the first place, a Limited Partnership or Limited Liability Company are supposed to have legitimate business purposes and to be established for a profit. If you place a personal residence into the FLP or FLLC, it would, therefore, appear that you would have to pay rent to the FLP or FLLC in order to make any business sense of the transaction. In fact, placing the residence into the FLP or FLLC could engender several adverse tax consequences, i.e., the loss of the capital gain, credit on the sale and the state real property tax exemption.

But, perhaps, the homeowner is willing to tolerate the adverse tax consequences in exchange for the purported asset protection benefits. The problem, however, is that it is likely the courts are going to find (because of the lack of business purposes) that the FLP or FLLC is really a sham. For example, the following language the Turner case (In re Turner 335 B.R. 140 Bkrpt. N.D. 2005) very pointedly highlights the problem:

"'Asset protection is not illegal and is honored by the law if done for a legitimate purpose. For example, an individual may do business through a corporation or limited liability company and will not be held personally liable for the debts of the entity. The assets of the corporation or limited liability company will not be considered the assets of the individual interest holder. However, an entity or series of entities may not be created with no business purpose and personal assets transferred to them with no relationship to any business purposes, simply as a means of shielding them from creditors. Under such circumstances, the law views the entity as the alter ego of the individual debtor and will disregard it to prevent injustice."

Therefore, placing a personal residence into an FLP or FLLC, is definitely a No-No in most instances.

Are there other Asset Protection Planning techniques available for a personal residence? Definitely. First of all, equity stripping should be considered. Obtaining a second trust deed line of credit is an excellent planning step. Transferring the residence to a Domestic Asset Protection Trust is also a very viable alternative. Sometimes a transfer to a Qualified Personal Residence Trust ("QPRT") or a Non Qualified Personal Residence Trust may be effective. In any event, any strategy should be thoroughly discussed and analyzed by competent legal counsel.

Jeffrey R. Matsen of Wealth Strategies Counsel helps people structure their personal and business assets in the best way possible to protect, preserve and transfer them in the most efficient and tax saving manner. For more information go to http://www.wealthstrategiescounsel.com

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