Your Home Is Your Castle: How to Protect It and Its Equity From Potential Lawsuits

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The family home and its equity are often a dermatologist’s most valuable assets. Moreover, many physicians have seen the value of their home increase significantly during recent years, potentially putting even more equity in a liability-vulnerable position. In this article, we will discuss the types of risks that can threaten a physician’s home and home equity and offer strategies and tools that can be used to protect these valuable assets.

Inside Risks: Use Insurance

Inside risks threaten the home because of potential liability created by the home and property. This would encompass injuries sustained on the property, such as those from slips and falls, and pool accidents, and even liability for guests who drink alcohol at the home and then drive, including guests of teenage or college-age children. While these risks are rare, they can be significant in terms of potential liability.

The best way to shield the home (and other assets) from inside risks is to use insurance—specifically, homeowner’s and umbrella coverages. Homeowner’s insurance will often be required by lenders if one has a mortgage on the property, but minimum required coverage amounts may not provide adequate protection. Umbrella coverage should also be considered to be essential, even if not required by lenders. Given its low cost (millions of dollars of coverage can often be obtained for approximately $1000 annually), umbrella coverage is an efficient asset protector. One should be sure that the terms of the umbrella policy fit with those of the homeowner’s and auto policies, so there is no gap in coverage.

Outside Risks: Use Legal Tools

Outside risks to the home are potential claims against the dermatologist (or their spouse) for any reason. These types of risks are typically more common, are top of mind for physicians, and include potential claims for medical malpractice, auto accidents, and contractual liability, and those arising from personal guarantees.

Dermatologists have several tools to shield their home and its equity from these types of potential claims.

1) State Homestead Law

Every state has a homestead protection law that says some amount of home equity is exempt from lawsuits and creditor claims. In a few states, homestead laws protect an unlimited value, although there may be some geographic limitations (Texas and Florida are examples). In those states, dermatologists need only to confirm that their home qualifies, and, thus, their home equity is fully protected.

However, in most states, including Illinois, New York, and California, the value that homestead rules protect is very low when compared with what real estate is worth. On average, state homestead laws protect less than $100,000 of equity—typically much less than the value of most doctors’ homes. In those states, additional protection options must be examined.

2) Tenancy by the Entirety

Often described as a quasi-exempt asset class, tenancy by the entirety (TBE) is a form of joint ownership for married couples that is available in several states. In essence, in states that recognize TBE, the home will not be subject to any claims against one spouse. This can be very valuable to a married couple when one spouse has significant liability exposure (eg, physicians). Inherent in TBE, however, are some limitations, including a lack of protection for joint risks.

3) Trusts

There are many types of trusts that can be extremely valuable in asset protection planning. When shielding a home, the 22 most popular are a domestic asset protection trust (DAPT) in certain states and a qualified personal residence trust (QPRT) in all states.

About 20 states, including Ohio, Connecticut, and Nevada, have adopted DAPT legislation. In these states, a physician can set up an irrevocable trust and be a beneficiary of the trust. When there is no lawsuit concern, the doctor can access the trust assets as the beneficiary, but if the doctor has lawsuit claimants pursuing them, the trust can be written so the trustee cannot make distributions to the doctor because they are “under duress.” Because there are no distributions anyway, a DAPT can protect the home extremely well. Additionally, the DAPT can be set up as a grantor trust, which means the trust is treated as if it were owned by the dermatologist for tax purposes. For these reasons, physicians must use experienced legal advisers when implementing both DAPTs and QPRTs.

4) Debt Shields

In states where homestead protection laws, TBE, and trusts are not viable options, a debt shield can be an effective way to preserve the equity of a home. Essentially, a debt shield is a loan against the equity in the home. For many homeowners, this is counterintuitive, because they want to pay down the mortgage as much as possible.

In some cases, using a debt shield does not require a new loan on the home. Rather, it may mean implementing a strategy of not paying the mortgage down more quickly than is required. The decision on whether (or to what extent) to pay down an existing mortgage can be examined from the asset protection perspective (could the funds be invested in another better-protected asset?) and the wealth accumulation perspective (could the funds be invested in another better-performing asset?). When a new loan is involved, the same analysis can be used.

From an asset protection perspective, the homeowner can simply use a debt shield to move the equity from the vulnerable asset (the home) to a better-protected asset. From an economic perspective, the decision process is to consider whether the cost of the equity move (the after-tax interest cost) is higher or lower than the return that the asset ultimately purchased with the loan proceeds can generate, along with the safety of the asset in which you are investing.

Conclusion

For most dermatologists, there is no more financially valuable and emotionally important asset than the family residence. Some states offer great homestead protection, but most provide an inadequate shield. Additional options include TBE, trusts, and debt shield strategies.

David B. Mandell, JD, MBA, is an attorney and author of more than a dozen books for doctors, including Wealth Planning for the Modern Physician. He is a partner in the wealth management firm OJM Group (www.ojmgroup.com).

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