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In today’s lawsuit-happy society, investors are anxious to protect
their assets from litigation. As a result, there are many
professionals in the business of helping investors meet this need.
But consumers need to be very careful about the advice they receive
and the path they choose.
A recent reader’s question illustrates this point perfectly. He and
his siblings own a debt-free commercial property and this is his
story:
“My brother was told by someone he implicitly trusts that
mortgage-free properties are "sitting ducks" for liens resulting
from lawsuits; that unless we "borrow" [most of the equity] we could
very well lose the entire property to "thieves" looking for
mortgage-free or low-mortgage properties. Our adult son is currently
going through a non-related legal battle that has cost him [tens of
thousands of dollars] so far. If his case goes to trial and should
he LOSE this trial, my siblings and I are being told we very well
could LOSE our co-owned property. Is that true?”
I can sure understand the reader’s concern. Either the ‘implicitly
trusted’ person didn’t understand the situation, or the brother
didn’t understand what that person said.
There are two issues that need to be addressed in this situation.
First, the risk to the siblings’ equity in this property due to
lawsuits, etc. Second, whether borrowing all the equity is the
proper way to mitigate that risk.
We live in a very litigious society and anyone can sue someone else
for just about any reason. That doesn’t mean they will be
successful. There has to be fault. For instance, if one of the
siblings above killed someone in a car wreck then he/she will
probably be sued. Any assets he/she owned can be targeted. If the
ownership in the above property is tenancy in common then the
portion owned by the other siblings is not at risk. If, however, the
property is owned via joint tenants, meaning that they all own the
property jointly, then the whole property would be at risk.
But what about the legal troubles of our reader’s adult son? Does
that put this property at risk? No, it doesn’t. If the son doesn’t
have any ownership in the property then it is not an asset that can
be pursued by the other party. Even though the son may be the
beneficiary, he doesn’t own it until his father dies.
So it is true that assets like real estate equity, as well as
stocks, bonds, and mutual funds can be subject to loss in a lawsuit,
but only where an asset holder is at fault. To reduce that risk, I’m
not sure borrowing out the equity is the best solution.
Borrowing the equity is just going to transfer the asset from one
place to another. If one borrows against the building, they have to
put that money somewhere else. Usually, it will be exposed in the
new place as well.
The risk of loss can be reduced through insurance. There is
liability insurance that can be used, but the protection isn’t
complete.
The most secure method, in my mind, of protecting someone’s assets
is for them to be owned by an irrevocable trust. An irrevocable
trust protects the assets from the claims of creditors.
An irrevocable trust protects its contents from outside threats, but
not from inside threats. Think of it as a bubble. The trust bubble
protects what’s inside from being affected by a lawsuit arising from
something outside the bubble—like an automobile accident. On the
other hand, if a rental property is in the trust bubble, that rental
property is exposed to lawsuits dealing with that property. If
someone slips and fall on the property and sues, that property can
be lost.
That’s why it is recommended that there be separate irrevocable
trusts for each property. That way, each is isolated from the risks
associated with the others.
Of course, you can see that this can become very involved. That’s
why not too many people do it. Also, irrevocable trusts can’t be
changed so it’s very important that they be set up correctly.
The bottom line is that even though real estate equity may be at
risk to a lawsuit, borrowing the equity to invest in something else
doesn’t seem to me to be the best remedy.
Nationally-syndicated financial columnist and Certified Financial
Planner® Jeffrey Voudrie provides personal, in-depth money
management services and advice to select private clients throughout
the USA. He’ll answer your financial question – FREE at
www.guardingyourwealth.com.
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