How do you protect your property from seizures resulting from personal claims against you or a member of your family? One of the most popular vehicles promoted to protect personal assets is the family limited partnership (FLP). Read on to learn how to protect your property.
Family Limited Partnership
An FLP is a limited partnership created by an agreement between family members. It is typically used as a business- and financial-planning entity that combines business operations with financial planning, estate planning and asset protection. Typically, the FLP is structured with at least one general partner and several limited partners.
The general partner(s) is entitled to a pro-rata share of the partnership's profits and losses, and enjoys all the rights of management and control of the partnership. The limited partners have the same pro-rata right to partnership profits, losses and distributions as the general partners, but have no rights of management or control of the partnership (unless the limited partner is also a general partner or acting on behalf of the general partner). The general partner(s) can be an individual, such as the parent(s) of the family establishing the FLP, or it may be an entity, such as a corporation or limited liability company controlled by the parents. The limited partners usually consist of the children of the parent general partners and, at least initially, the parents can be both general and limited partners.
As an asset-protection vehicle, an FLP offers a level of protection for the assets you transfer to the partnership while allowing you to maintain control over the transferred assets. While the FLP owns the transferred assets, the general partner owns a controlling interest in the FLP. This individual manages and controls the affairs of the partnership and can buy or sell any partnership assets, retain proceeds from those sales or distribute the proceeds to general and limited partners.
Why Is an FLP a Good Asset-Protection Device?
Let's say your dog bites your neighbor, who sues you and receives a $500,000 judgment against you. Excluding any liability insurance that might be available, your neighbor would like to satisfy the judgment from assets you own. However, he finds that you no longer own bank accounts, investments or property as an individual. Instead, most of these assets are held by the FLP in which you have a controlling interest. Generally, your neighbor/creditor cannot seize partnership assets to satisfy the judgment against you, nor can a judgment creditor reach into the partnership and take specific partnership assets to satisfy a partner's debt or judgment. Since title to the assets is in the name of the partnership, the assets in it may not be taken to satisfy the judgment.
Since you do have an interest in the FLP, your creditor can attempt to satisfy its judgment through use of a charging order, which gives it the right to any distributions from the partnership to the debtor/partner. The order remains in effect until the creditor has been paid in full or until the expiration of a statutory time limit. In other words, money paid to you out of the partnership can be seized by the creditor until the amount of the judgment is satisfied. To avoid this, the general partner and controlling member of the FLP can direct that the partnership retain rather than distribute distributions.
In addition to the charging-order remedy, some states allow a creditor to foreclose on the debtor/partner's interest. An order of foreclosure means that the creditor can seize and sell the debtor/partner's interest in the partnership. This action entitles the creditor to the debtor/partner's share of partnership assets, even to an amount exceeding the value of the judgment. A creditor with foreclosure rights is in a better position to satisfy his claim from partnership assets if you are, in fact, a partner.
The Benefits of Trust Assets
If neither you nor your spouse is a partner of the FLP, you have no direct partnership interest to seize. One way to accomplish this is to set up the FLP interest to be owned by a trust specifically created for this purpose.
Trusts have many varied uses in asset protection planning. A few trust types and uses include these three:
Inter-Vivos or Revocable Living Trust
A revocable living trust has become a staple for transferring assets at death. Property in a trust generally does not pass through probate, so the transfer is private and without court interaction (which can cause delays and cost probate filing fees). Trust assets pass to beneficiaries as quickly as you wish according to the terms of the trust.
Irrevocable Life Insurance Trust
An irrevocable life insurance trust is used primarily to own life insurance for the benefit of your spouse or children. By having the trust own the policy, if certain other requirements are met, the value of the policy will not be included as part of your estate, thus escaping estate taxation. Generally, you will not have control over the trust or its assets.
Qualified Personal Residence Trust
In addition to housing your family, your home is often worth more than any other single asset you own, and its loss could be disastrous both financially and emotionally. A qualified personal residence trust can protect your home and transfer it to your children over time.
After transferring your interest in the home to the trust, you retain the right to live there for a specified number of years. At the end of the term or at your death, whichever occurs first, the home passes to the trust beneficiaries (usually your children). The house will not be included in the value of your estate, and thus will escape estate taxation, if you outlive the term of the trust. However, if you die prior to the end of the term, then the entire value of the home is included in your estate.
A Word About Fraudulent Conveyances
While protecting assets from potential claims is both practical and necessary, deliberately hiding assets from a creditor whose claim has already been realized, or attempting to defraud creditors after their claim has been realized, may be considered a fraudulent conveyance punishable by fine, imprisonment or both. If you deliberately shelter assets to defraud or delay creditors, your liability may extend beyond the assets you're trying to protect. Check with your legal advisor about the fraudulent-conveyance laws in your area and be sure your asset-protection plan stays clear of violating those precepts.
The Bottom Line
Because we live in a litigious society, planning to protect your assets should be a priority. Don't put yourself at risk for a disaster you can mitigate with proper planning. By choosing the asset-protection structure or structures that best suit your situation, you'll be able to safeguard your finances for yourself and your family.