NFIB

More Help With Taxes
02/ 03/ 2003

The February/March MyBusiness magazine was full of information on small business taxes. Now you can find even more tips online. The following is an excerpt from Wealth Protection: Build and Preserve Your Financial Fortress.

Owning Your Home in a Limited Liability Company

As we explained in Chapter 29, family limited partnership and limited liability companies (LLCs) are extremely use protection tools because of their "charging order" protections. Strategy here then simply involves owning your home through LLC. This might seem simple, but there is another laver of coin due to the special tax benefits afforded your home. This complexity also affects why we recommend an LLC, not an FLP.

Tax Rules

Under federal tax rules, your home--defined as your "primary residence"--has special benefits. These benefits can only home. Essentially, if you're single, you have a $250,000 tax exclusion on the sale of your home (i.e.., there are the first $250,000 in capital gains). If you're married, this is $500,000. At a 20 percent capital gains tax rate, this be between $50,000 and $100,000!

This exclusion applies if both parts of a two-part test either spouse or both spouses have owned the home for out of the five years prior to the sale, and (2) both spouses there and treated it as their primary residence during the period. If the taxpayer is single, then both conditions a person.

Solutions

Because this tax benefit is so significant, we have to in we won't violate tests (1) and (2) by protecting a home in an LLC. If an FLP or an LLC owns the home for more, the past five years, that means that neither of the spouses single client) have "owned" it for at least two of the This would violate, test (1) and cause a loss of the tax benefit.

There are two ways to get around this problem: (1) The clients transfer the home to an LLC or an FLP for at most three years at a Then, they would retransfer the home back to their own names years. This is obviously not ideal--the transfer costs can be significant, and it's a practical headache. (2) Have a single-member the home. The LLC would only be owned by one spouse (if a married couple) or the single client The single-member LLC is considered by the IRS to be a "disregarded entity" for tax purposes. Thus, if a single-member LLC owned the home, for purposes of the test, the home would be considered owned in the client's name directly and test (1) would be satisfied. The LLC would simply be "disregarded." As long as the client met the residency test (2), the benefits would be preserved. Be sure to check with a licensed tax advisor on this strategy, as this is the type of law that changes quite often.

The main drawback to using an LLC to shield your home--or any "real estate, for that matter--is that your existing bank/mortgage may not allow you to transfer the title out of your name(s). Almost every mortgage note today is drafted with a "due on transfer" cause, allowing the bank/mortgage lender to call the note if you transfer the title to your home out of your name. Typically, they have exceptions to this clause for transfers between spouses, to family members, to trusts, and so on. However, they typically do not have such an exception for transfers to FLPs and LLCs. Thus, you will often need the written permission of the bank/mortgage lender to make such a transfer. If they have sold the loan to Fannie Mae or some other mortgage investor, this is impossible. Even if they still hold the loan, it can be very difficult.

Often, many of our clients use this reason as an opportunity to shop around and refinance their home. When negotiating with a bank at the outset, it is a hundred times easier to arrange for a property to be owned initially by an FLP or an LLC than it is to transfer the property to such a tool after the loan has closed. If rates are low (as they are at the writing of this book), then it might make a lot of sense to refinance the property and to make the transfer to the LLC as part of the refinancing.

Christopher Jarvis and David Mandell are co-authors of Wealth Protection: Build and Preserve Your Financial Fortress, which was released in October, 2002 and is available at www.mywealthprotection.com. Their firm, Jarvis & Mandell, LLC (www.jarvisandmandell.com) provides asset protection, tax reduction, insurance and investment solutions for people across the country. For a free audiocassette or to speak with Messrs. Jarvis or Mandell, please contact them at (800) 554-7233.

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This Web extra is a supplement to the MyBusiness Manual, "The Essential Guide to Small Business Taxes," which appears in the February/March 2003 issue.

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