Residential LLC's

A Residential LLC is a unique use of an LLC. There's not anything out there in the universe called “Residential LLC”. That is our word and it reflects a particular way of structuring an LLC for purposes of owning a residence. This is an asset protection move that we use, particularly with high net worth or high income clients that have a low risk tolerance or are risk averse. 

Here is what happens if a person owns a piece of real estate, either in their personal name or in the name of their revocable trust as a revocable trust does not protect your assets because it's revocable. 

So we have devised what we call a “Residential LLC.”

Typically the Residential LLC is owned 95.1% by the revocable trust and 4.9% by the irrevocable trust. 

Why 4.9%? Why not one percent?

The interest in the second party has to be more than nothing. It has to be something. So somewhere between one and five, there's a line. We don't know where it is. And at 4.9% voting, how much control does the irrevocable trust have? Zero.

Why do we want 95.1 in the revocable trust? Because if it's 95.1% in the revocable trust we step up in basis. So now by having that residence titled in the name of this LLC, what have we got? We have protected the title from the judgment lien automatically attaching and we still get a step up in basis when we die. 

But what's the downside of this? What's gonna happen? Why don't we just put the house in the Family Bank Limited Partnership?

Because the IRS classifies it as a business which then turns the residence into a Rental Property.

You have to pay rent and if you don't pay rent, you're cheating and so you get audited and you get hammered. Now you have turned your house into a rental and you don't get the Home exemption and Capital Gains on a Rental Property. So we're not gonna put it in the Family Bank. We're gonna put it in the Residential LLC. 

We have a special agreement to document this. We call it the “Occupancy Agreement.” It's an addendum to the Operating Agreement and it basically says we're putting the title to our residence in this LLC for convenience in holding legal title as part of our estate plan, but it's still our personal residence for all purposes and we have the right to occupy it rent free. We are personally responsible for all of the costs including the mortgage and the insurance and the property taxes and maintenance.

Why do we need this Occupancy Agreement?

This is significant because the County Assessor is going to attempt to classify the property as a Rental Property. Therefore, they will attempt to change the tax status of your property as a rental and are going to charge you more taxes.

But if you file a little piece of paper with the County Assessor that says, that it is your residence in which you are holding in an LLC for convenience in your Estate Plan, then the County Assessor's office and they should accept it. And then five years later they do the same thing.

There is no way to proactively tell the county assessor, this is a personal residency because even if you have told them in the past and established that once, it will come up in their regular audit. You will get the little letter in the mail notifying you of this audit and you have to resubmit the Occupancy Agreement. 

So now we have successfully protected the title to the property from creditors. We've preserved the step up in basis and we've preserved the tax, the property tax status of the uh residence for property tax purposes. 

If we want to refinance it; deed it out of the residential LLC, put it in their personal names, get the new loan as soon as the new loan closes, and put it back to the residential LLC.

Can the Residential LLC prevent fraud?

There have been instances that have been in the news lately of people fraudulently recording devices that seek to convey the title of your property to someone else. There are people who will fraudulently record a bogus deed claiming ownership. However, having it owned by the Residential LLC makes that more difficult for anyone to do.

While it makes it harder to find, it is not invisible, acting as a smokescreen. A smokescreen makes things hard to see, but it doesn't stop bullets. Bullets will go through the smoke. So they can still, if they find you, do unlawful things. But it slows that process down. 

Now, there's another issue we want to address: say we want yet another layer of asset protection and tax benefits.

This is where we use a Revolving Credit Line. We sometimes call this the Equity Strip where we will put a Mortgage on the Revolving Credit Line Mortgage. Typically, the lender will be the Family Bank if they have one. If they don't have one, the lender can be the Irrevocable Trust. 

A Revolving Credit Line Promissory Note works like a credit card. You have a credit limit. You can borrow up to this amount or you can borrow zero. What's your balance? Well, somewhere between zero and that ceiling, but it has the effect of committing that equity. So it's kind of like if you go to the gas pump and use your debit card. When you stick your debit card in that gas pump, it will recommit $150 in your bank account. But it only put in $57 for the gas. So once it clears after a few business days, only $57 will have been taken out of your account. And it can mess you up. You think I've got money in there and you go to the grocery store and then your debit card gets declined and you go, well, wait, I, I know I have money in there. It's because the gas station put a hold for up to $150. 

So, in a similar fashion, this credit line puts a hold on your equity in the house. Now if the bad guy comes along and sues our emergency room surgeon and gets a judgment for a gazillion dollars and comes to collect it, they record the judgment and they see that you don't own your house. 

Then they hire a lawyer who thinks he's clever and, and he's not, but he thinks he is, he thinks, well, I'm going to assert my lien against your residence in that Residential LLC because he thinks it's fraudulent because the only reason you did it is to avoid predators but that theory fails. It's failed many times. But, let's just say, hypothetically, that a judge has a bad day, so he rules against our client that day and he lets the creditor get through the barrier of the Residential LLC. 

Now, what does the creditor find?

There's no equity in the house, so the house becomes very unattractive and they leave it alone.

Say a client has pending litigation and we did the home equity line of credit and the Residential LLC has a line of credit for $800,000 against the house and the client decides to sell the house.

If they take the money personally with all the wolves at the door, they're gonna come grab it. 

So when we close escrow, $800,000 is going to go to the lender which is the family bank and, and the extra equity goes to the Residential LLC. This is what we call the “Samurai Hostage” in asset protection.

Who will do this typically are high income, high net worth clients that if we tell them this costs you an extra $5000 in change to protect your house. Is it worth it to you?

That's the question.

Some will say yes and some will say no. If they decide not to do it, we'll say I told you I recommended this and we discussed the pros and cons and after discussion you decided not to do it.

So, three years later when they are getting sued, they’ll ask if it is too late to do a Residential LLC? Unfortunately at that point, it is too late for the Residential LLC.

Real Life Application

A long time ago there was one of our clients who had two little children playing in the backyard with two neighborhood children about the same age with their family dog.

The neighborhood children had to go home, so all four children came out of the backyard and the two neighbor children crossed the road.

The family dog was in the middle of the road and suddenly an 18 year old on a motorcycle going 85 MPH (felony speed) came flying around the corner and hit the dog.

The motorcycle skidded for 132 feet in front of the kids. The 18 year old ended up in the ICU and nearly died. So he sued the homeowner because there are strict liability statutes for dog at large. If the dog is not on a leash and it's involved in the accident You can argue the dog didn't cause the accident, the accident was caused because the guy was going 85 miles an hour and had a felony citation, but a felony citation is inadmissible as evidence.

The mere fact that the dog was not on a leash and was involved in the accident means the owner of the dog is strictly liable for 100% of the damages. So they sue the homeowner for a million dollars above policy needs.

The homeowners insurance company hires a litigation lawyer to defend the homeowner and a year into the litigation, the insurance company’s hired lawyer calls the homeowner and says, “Good news! I've been hounding these guys for a year. We've worked on them really hard. You're only gonna have to come out of pocket 80 grand and this lawsuit goes away.”

This is what the homeowner said: “Great. Let's go to trial.” The litigation attorney went ballistic and said, “Are you kidding? That's stupid. You are a moron. If you go to trial, you will lose and it won't be 80 grand, it will be a million dollars. You are crazy. You're an idiot.”

And the homeowner said, “I'm confident that the plaintiff's counsel has done their homework. They can have what they can find. We're going to go to trial and they're going to win, but spend hundreds of thousands of dollars in legal fees and they're gonna get the judgment and when they go to collect it, they're going to get zero. Let's go to trial.”

Once again, the insurance company lawyer cursed and called the homeowner bad names and hung up. Fifteen minutes later, the insurance company lawyer called back and said, “This is bizarre. I've never seen anything like this in my life. They're gonna settle for policy needs zero out of pocket. This goes away.”

The Homeowner says, “Thank you.”

That's why we do what we do right here because that client ate the cooking that we serve in our law firm and had the Family Bank, the Residential LLC, and the Family Office and there were no assets available for that litigation to collect on.

It changes your negotiating posture and motivation.