Florida Asset Protection Blog

Tax Trap From Foreclosure of Investment Property

I saw an email about income tax liability associated with foreclosure or bankruptcy sent by attorney Larry Heinkel. The email addresses income tax liability from the foreclosure of properties which have previously been depreciated for tax purposes. Most people know that if a bank forgives part of a mortgage loan in the course of a short sale or deed in lieu that the amount of debt forgiveness may be taxable if the mortgaged property is an investment or second home. A new law has eliminated debt forgiveness tax for principal residences. A person who is insolvent at time of short sale or deed in lieu, or who files bankruptcy, has no liability for debt forgiveness taxation. Mr. Heinkel points out a different tax trap.

If the debtor has previously depreciated the property for income tax purposes the tax basis of the property has been lowered from its original purchase price. The short sale or deed in lieu may be treated as a “sale or exchange” which triggers income tax on the difference between the property value and the adjusted basis. This tax liability is not eliminated by insolvency or bankruptcy. People considering walking away from investment property should check with their CPA to see if they may incur tax liability by the recapture of prior tax depreciation.

posted by Jonathan Alper, asset protection and bankruptcy attorney, Orlando, Florida

Life Insurance Proceeds: Are Death Benefits Exempt

A husband purchased a large life insurance policy naming his wife as beneficiary. The policy accumulated cash value. The husband and wife had joint creditors. The husband died and the insurance company paid the policy proceeds to the surviving spouse. The surviving wife asked me if the creditors can go after the life insurance proceeds

The insurance policy was exempt from creditors during the husband’s lifetime. Cash value of life insurance is exempt under Florida statutes. The death benefit is exempt from the husband’s creditors after his death. The proceeds once paid to the surviving spouse are not exempt. The Florida statutes do not protect the proceeds of life insurance (contrast to the protection of annuity proceeds in whatever form). I believe the joint creditors and the wife’s individual creditors, if any, can levy upon the life insurance death benefit proceeds once paid to the survivor.

posted by Jonathan Alper, asset protection and bankruptcy attorney, Orlando, Florida

Relief From Income Tax Associated With Some Short Sales

Previous posts on this blog have discussed income tax risk associated with giving banks a deed in lieu of foreclosure or arrangements for a short sale. The general rule is that foregiveness of debt, including a bank's waiving mortgage deficiency liability, is taxable income. Last month, December, 2007, Congress passed a bill to relieve many homeowners from income tax liability associated with deeds in lieu, short sales, or foreclosure. The Mortgage Forgiveness Debt Relief Act of 2007 states that homeowners will not be subject to income tax from release from mortgages used to buy or improve their primary residence. Mortgage Forgiveness Debt Relief Act of 2007

The Act exempts up to $2,000,000 of debt forgiveness for married couples. Yet, not everyone is eligible for this income tax shelter. There are time limits on this legislation. The Act applies to debt forgiveness from residential mortgages from January, 2008 through December, 2009.

Only relief from mortgages on primary residences is tax protected. A debtor can still be taxed from a deed in lieu, short sale, or a foreclosure on an investment property, second home, or a business mortgage. Also, many debtors took second mortgages on their homes during the housing bubble to pay off and consolidate credit card debts. Mortgage companies often required borrowers to pay off all credit card debt with finance proceeds in order to increase their ability to pay their home mortgages. Any portion of forgiven mortgage debt used to pay credit card debts will still be subject to taxation.

Debtors whose mortgages do not qualify for this legislative relief may still escape debt forgiveness taxation by filing bankruptcy prior to the foreclosure or by filing IRS forms declaring their insolvency at the time of foreclosure

Another interesting comment on this new law was posted by Oregon attorney Kent Anderson on the Bankruptcy Law Network Link: Home Loan Foreclosure No Longer a Tax Trap? : Bankruptcy Law Network.

posted by Jonathan Alper, asset protection and bankruptcy attorney, Orlando, Florida

Homestead Owned by Corporation: Spouse's Rights

A man owned a home and decided to get married. Before the marriage he created a Florida corporation and deed his home into the name of the corporation. He owned all the shares of the corporation. Later, when the husband wanted to refinance the house the lender inquired whether the non-owner spouse had an interest in the homestead which she would have to waive in order to give the new lender an enforceable mortgage. Although this issued arose in the context of a real estate transaction, the issue is relevant to understanding homestead rights and protection.

Florida law liberally interprets homestead protection and has a bias to give people an enforceable, vested legal interest in the property where they live. The Florida Constitution limits homestead interests to natural persons, but it does not define the nature of the homestead interest.. Almost any beneficial interest in a homestead property is sufficient to get homestead protection. For example, the beneficiary of a trust which hold legal title to a homestead may qualify for a protected interest in the homestead.

This case if different. The homestead is owned by a corporation which is not a natural person. The wife has no beneficial interest. She is not a stockholder in the corporation. I do not think the wife has a protected interest in the house in which she resides; she is a tenant in the corporation’s property. People who intend to protect their home from creditors should not transfer legal title to a corporation, partnership, or any other entity other than a revocable living trust of which they are the beneficiary.

posted by Jonathan Alper, asset protection and bankruptcy attorney, Orlando, Florida

LLC Membership Interest in Bankruptcy

Limited liability companies provide asset protection benefits, not because the membership interest in an LLC is exempt from levy and collection, but because the Florida statutes limit a creditor’s collection remedies to that of a charging lien on LLC distributions, if any, to the debtor. This past week a client with a valuable membership interest in a multi-member LLC asked whether his LLC interest would be protected from a trustee in the event the debtor filed bankruptcy. The issue is whether collection restrictions imposed by Florida statutes, or other restrictions imposed on creditors by the LLC operating agreement, are binding upon a bankruptcy trustee. It seems that the answer depends on terms and conditions of the LLC operating agreement, and upon interpretation of an uncertain issue by the particular bankruptcy judge.

There is very little case law on the status of LLC membership interests in bankruptcy. The consensus is that where the LLC operating agreement is an "executory contract" the bankruptcy trustee cannot sell the debtor’s membership interest, but where the operating agreement is not executory the LLC interest is deemed to be a non-exempt property interest which is subject to the trustee’s powers over the debtor’s bankruptcy estate. Whether the LLC agreement is an executory contract depends upon whether the court finds that the agreement imposes affirmative obligations on the debtor as a consideration for receiving his rights as a member. For example, an LLC that excuses the debtor from ongoing obligations to contribute additional money, to vote in LLC affairs, or to assist with LLC business is probably not an executory contract. An operating agreement is more likely to be an executory contract protected in bankruptcy if the debtor’s rights to distributions are contingent on the debtor/member’s continuing performance or duties.

There is a good overview of this legal issue in an article published in the January, 2007, Florida Bar Journal written by Thomas Wells and Jordi Guso. ink: Bar Journal Article.

posted by Jonathan Alper, asset protection and bankruptcy attorney, Orlando, Florida

Tenants by Entireties Property in a Living Trust

Prior to a judgment being entered against him a judgment debtor owned financial accounts jointly with his wife. He and his wife created a joint living trust for estate planning purposes. They transferred title of the financial account to their joint trust. Property owned jointly by the debtor and his wife is exempt from the judgment against the husband/debtor because the property is deemed to be owned as “tenants by entireties.” The issue is whether the same financial account is tenants by entireties property after it was titled in a joint living trust.

I don’t think the financial account is protected from creditors after transfer to the joint living trust. Homestead property owned by a living trust is still deemed protected homestead according to case law in Florida. The issues in a living trust ownership of homestead are different from trust ownership of marital property. The terms of a typical joint living trust destroy entireties ownership. A typical joint living trust document creates separate shares of ownership for husband and wife, and it divides all assets equally between the separate shares. The separate shares are designed to maximize estate tax savings. Once the living trust document divides a financial account into separate shares there can no longer be qualifying entireties ownership.

There are living trust documents which state that notwithstanding anything else in the trust the married grantors intend to retain tenants by entireties ownership of joint property put into the trust. I know of no court case interpreting the effectiveness of this type of savings clause. I don’t think conveying joint property to a joint trust is effective asset protection. There are other ways to use a living trust for estate planning purposes and also retain tenants by entireties protection. This is one example of the conflict between the goals of asset protection and estate tax planning. Effective asset protection planning preserves both goals.

posted by Jonathan Alper, asset protection and bankruptcy attorney, Orlando, Florida

Tenants by Entireties: Spouses Live in Different States

A client presented an interesting question about tenants by entireties ownership. Client was married with children. His wife and children lived in New York. The client lived primarily in Florida where he ran his business. The client had a Florida drivers license, used Florida as his primary address, and appeared to qualify as a Florida resident. Before getting married, the client and his then girlfriend opened a joint stock account at the New York office of a national brokerage. The client is being sued and wants to know if his brokerage account is protected as tenants by entireties property.

Real and personal property owned jointly by husband and wife is immune from creditor levy under Florida law as tenants by entireties property. Some other jurisdictions protect T by E property by statute; Florida’s protection is based on judicial decisions of common law. The law applies to debtor’s who reside in Florida. There are no judicial decisions I know of that require the non-debtor spouse to be a Florida resident as well. Therefore, this spouse’s New York residency should not affect the debtor’s protection of the stock account.

However, there is another problem. T by E protection requires that the debtor acquired the jointly owned property during the marriage. In this instance, the debtor opened the account with his spouse before they were married. The stock account is not protected as tenants by entireties property. The debtor should open a new joint stock account with his wife in Florida. The new account will be T by E property. A creditor might argue that the opening of the new account is a “fraudulent conversion” of the debtor’s separate interest in the pre-marital stock account to the protected T by E account. The debtor would have to show other reasons for opening the new stock account other than creditor protection.

posted by Jonathan Alper, asset protection and bankruptcy attorney, Orlando, Florida