BFSG Blog - Benefit Financial Services Group

Homestead Exemption – Protect Yourself from Creditors & Reduce Property Taxes

By:  Henry VanBuskirk, CFP®, Wealth Manager

One of the most heavily quoted statements that I’m sure that you have heard at some point in your life is, “Nothing in life is guaranteed, except for death and taxes”. I’m not here to tell you about a magical snake oil that makes you live forever (since that of course doesn’t exist). We live in the real world where death and taxes are unavoidable. I am here to talk to you about how you can help protect yourself and your family from the effects of a loved one’s passing away, how you can legally reduce your property tax bill depending on which state you live in, and how you can help shield yourself from creditors. What I am talking about is electing a homestead exemption.

Each state has its own homestead rules and for purposes of making a succinct article, I am only going to focus on California, Arizona, Florida, and Texas. If your primary residence is in one of the other 46 states, please check with your local county assessor’s office to check what the rules are and what options are available to you in your state.

First off, what is the homestead exemption? The homestead exemption is a way to minimize property taxes for a homeowner’s primary residence. It is also a legal provision that also can help shield a home from unsecured creditors following the death of a homeowner’s spouse or the declaration of bankruptcy.

 Here is an example of how the homestead exemption can help lower your property tax bill.

Example:  Assume that the value of your home is $500,000 and your property tax rate is 1%.  Your property tax bill would then be $5,000.  Assume that you are eligible for a homestead exemption of $50,000.  This would then reduce the taxable value of your home to $450,000.  Your property tax rate would still be 1% and your property tax bill would be reduced to $4,500.

There is also a legal provision that allows unsecured creditor protection against the forced sale of your home when you elect the homestead exemption. Notice how it states ‘Unsecured’ instead of ‘Secured’ creditor protection. An unsecured creditor is any creditor that is loaning money to you without obtaining specified assets or collateral. Some examples of unsecured debt include credit cards, student loans, and unpaid medical bills. A secured creditor is any creditor that is loaning money to you with obtaining specified assets or collateral. Some examples of secured debt include a mortgage, auto loans, and a line of credit against your investment account.

It is important to discuss what the homestead exemption can and can’t do, so that one does not have unrealistic expectations on what asset protection and property tax bill reduction a state will allow. In general, the protection against unsecured creditors is limited and is only applicable to the homeowner’s equity in the home. If the limit is exceeded, unsecured creditors still may force a sale of the home, but the homeowner may be allowed to keep a portion of the proceeds. It will also not stop a bank foreclosure.

Now that we have the basics down, I will now get into more detailed information for California, Arizona, Florida, and Texas.

California

California passed Assembly Bill 1885 back in 2020. This legislation dramatically increased the unsecured creditor protection in California to a minimum of $300,000 or the median price of a home in your county, not to exceed $600,000. For example, the median home price in Orange County (OC) is $1,100,000, so anyone in OC would get an exemption of $600,000. Given the current home valuations in CA, it is hard to think anyone would get $300,000. Most likely, individuals will get whatever the median home value is in their county. The California Constitution provides a $7,000 reduction in the taxable value for a qualifying owner-occupied home. The home must have been the principal place of residence of the owner on the lien date, January 1st.

To apply for a homestead exemption, you would do so by completing the application online with your local county assessor’s office. It is also recommended that you discuss with your local county assessor’s office your unique situation and what options are available to you.    

Arizona

Arizona does have homestead exemption laws, but none of those laws allow you to decrease the taxable value of your home for purposes of potential savings on property taxes.  As of January 1, 2022, Arizona  increased the homestead exemption to $250,000 from the forced sale of your home by unsecured creditors for any person who:

  • Has an interest in real property (owns a single-family residence), or
  • Owns a condo, or
  • Owns a mobile home, or
  • Owns a mobile home plus the land on which that mobile home located.

This legislation though did weaken the protections provided by the homestead provision for individuals as well. This bill provides more ways for creditors to collect on civil judgments.

Florida

Florida is one of the few states that have unsecured creditor protection. Simply put, a creditor cannot force the sale of a homestead to satisfy a judgment. This protection from creditors combined with the fact that Florida does not impose state income taxes, shows why it’s not surprising to see more and more people relocating to the Sunshine State. Florida also allows for the following homestead exemption rules that all must be applied for. Applying for a homestead exemption would grant you the following:

  • A $25,000 exemption that is applied to the first $50,000 of your property’s assessed value if your property is your permanent residence and is owned on Jan 1st of the tax year applied for.  This applies to all taxes, including school district taxes.
  • An additional exemption of up to $25,000 is applied if your property’s assessed value is between at least $50,000 and $75,000. However, this exemption is not applied to school district taxes.
  • You could also qualify for the 3% Cap Save Our Homes assessment limit. This limits the increase to the assessed value of a homestead property for tax purposes to a maximum of 3% per year or the amount of the change in the Consumer Price Index, whichever is lower.

You would apply either by an online application or by going to your local county property appraiser’s office for a paper application. Either way, it is recommended that you discuss your unique situation with your local county property appraiser’s office to check what options are available to you.

Texas

Texas, like Florida, also offers unsecured creditor protection and does not impose a state income tax. This of course does have some limitations. The property tax in Texas is locally assessed and locally administered tax. However, there are some limits based on the acreage and use of the homestead. 

Here are the many types of exemptions available to you if you are applying for a homestead exemption:

  • A $40,000 residence homestead exemption for the home’s value for school taxes.
  • If there is a special tax for farm-to-market roads or flood control, you may receive a $3,000 exemption for this tax. If your county grants an optional exemption for homeowners aged 65 or disabled, that household would only receive the local-option exemption
  • For Disabled persons or persons aged 65 or older:
    • You can qualify for a $10,000 residence homestead exemption for school taxes in addition to the $40,000 exemption for all homeowners. If the owner qualifies for both the $10,000 exemption for over 65 and the $10,000 exemption for disabled homeowners, the owner must choose one or the other for school taxes.
    • Any taxing unit may offer an additional exemption up to $3,000.

To apply for a homestead exemption, you would need to check with your local appraisal district on how to apply and discuss what options are specifically available to you.

Summary:

The goal of this article is to get you thinking about asset protection planning and to offer our services to help you reach your asset protection goals. Our team can work with you and an attorney to make sure those goals are being satisfied.

Sources:

  1. https://www.investopedia.com/terms/h/homestead-exemption.asp
  2. https://www.investopedia.com/terms/u/unsecuredcreditor.asp
  3. https://www.investopedia.com/terms/s/secured-creditor.asp
  4. https://www.boe.ca.gov/proptaxes/homeowners_exemption.htm
  5. https://www.boe.ca.gov/proptaxes/homeexem.htm
  6. https://www.sccassessor.org/tax-savings/transferring-your-assessed-value/senior-citizen-over-age-55-outside-county
  7. https://www.azleg.gov/ars/33/01101.htm
  8. https://www.pbcgov.org/papa/3-percent.htm
  9. https://www.pbcgov.org/papa/homestead-exemption.htm
  10. https://comptroller.texas.gov/taxes/property-tax/exemptions/
  11. https://www.realtor.com/realestateandhomes-search/Orange-County_CA/overview   

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

Upcoming Compliance Deadlines

September 2022

15th: Required contribution to Money Purchase Pension Plans, Target Benefit Pension Plans, and Defined Benefit Plans.

Contribution deadline for deducting 2021 employer contributions for those sponsors who filed a tax extension for Partnership or S-Corporation returns for the March 15, 2022 deadline.

30th: Deadline for certification of the Annual Funding Target Attainment Percentage (AFTAP) for Defined Benefit plans for the 2022 plan year.

October 2022

17th: Extended due date for the filing of Form 5500 and Form 8955 for plan years ending December 31, 2021.

Due date for 2022 PBGC Comprehensive Premium Filing for Defined Benefit plans.

Contribution deadline for deducting 2021 employer contributions for those sponsors who filed a tax extension for C-Corporation or Sole-Proprietor returns for the April 18, 2022 deadline.

Due date for non-participant-directed individual account plans to include Lifetime Income Illustrations on the annual participant statement for the plan year ending December 31, 2021.

Q&A Corner

Q: I didn’t file my 12/31/21 plan year end Form 5500 by 7/31/22, now what?

A: Contact your Form 5500 preparer! First, confirm whether or not an extension applies. This would occur with a Form 5558 filed before 7/31, or possibly a special extension or automatic extension. If so, you have until 10/15/22 to file the Form 5500. No extension? The Delinquent Filer Voluntary Compliance Program (DFVCP) is a DOL program designed for this purpose. Using this program, the maximum penalty is $750 for a small plan and $2,000 for a large plan. This is much lower than the IRS late filing penalty ($250 a day, up to $150,000) and the DOL late filing penalty (up to $2,529 per day, with no maximum).

Q: What if I didn’t sign the document restatement for my 401(k) Profit Sharing plan that was due by 7/31/22?

A: This plan document restatement (commonly referred to as Cycle 3, Tricycle or Post PPA) required signatures by 7/31/22. Contact your TPA as soon as possible, or your document provider if handled by someone other than your TPA. The steps to ensure your document remains in compliance will vary based on the type of plan document and provisions included, but the options are not as cut and dry as a late Form 5500. Be sure to act promptly!

New IRS Pre-Examination Compliance Program Announced

In June 2022, the IRS began piloting a pre-examination retirement plan compliance program. This is beneficial to plan sponsors because it provides an opportunity for plan sponsors to correct mistakes at a reduced cost and possibly avoid a full IRS examination. Anytime you receive a correspondence from the IRS or DOL, you should inform your TPA or service provider as soon as possible to determine if a response is needed. In some situations, no action is required. In this case, however, the letter opens a 90-day window. Within that time frame, you will need to:

  • Review your plan document and operations.
  • Determine if they meet current tax law requirements.
  • Self-correct any mistakes that qualify under the Employee Plans Compliance Resolution System (EPCRS).
  • Respond to the letter and provide your conclusion:
    • No mistakes were found.
    • Mistakes were found and self-corrected (provide the details of the error and correction).
    • Mistakes were found, but they do not qualify for self-correction. You may request a closing agreement. This means that the cost could be much less than if the IRS found the mistakes during an IRS examination.

Your TPA or service provider will be able to review the plan information with you to ensure that all necessary steps were previously taken to maintain compliance. If an issue is discovered as part of this review, they can discuss the correction options available. Of course, you don’t have to wait until you receive a letter from the IRS to be sure your plan is compliant! Understanding the terms of the plan and operating the plan according to the document are very important actions to help avoid mistakes.

Once you submit your response, it is reviewed to see if they agree with your conclusion. The IRS will either issue a closing letter or conduct a limited or full scope examination. The intention is that this program will reduce taxpayer burden and the shorten the time spent on retirement plan examinations. The end date of this pilot program is not known, but the process may continue after the pilot period if they find it to be successful.

If you do not provide a response, you will be contacted to schedule the examination. Of course, this is the least favorable option. It is best not to ignore any letter from the IRS or DOL. It is in the best interest of your plan to take action when it is requested, and a 90-day window can close pretty fast!

Form 5500 Insights

Every year, most employers file a Form 5500 for each qualified plan that they sponsor. The purpose of the Form 5500 is to provide required information to the Department of Labor (DOL), but it can also provide valuable insight to the plan sponsor.

The Form 5500 has several “types” and the type of form you file will vary based on the size of your plan. The Form 5500-SF is generally for small plans with under 100 participants and the Form 5500, which requires a number of attached schedules, is generally for large plans with 100 or more participants. Additionally, the full Form 5500 requires an accountant’s audit. In some cases, even small plans may be required to file a Form 5500 if the plan assets include employer securities or if the plan is considered a multi-employer or pooled employer plan.

There is an even briefer version of the 5500 series called the 5500-EZ. This version of the 5500 is typically filed by one-participant plans (usually the self-employed (and spouse) or one or more partners (and spouses)). The following are examples of the useful information provided on the Form 5500-SF or Form 5500:

Participant Count

Small plan vs large plan

  • Whether your plan is considered a large or small plan depends on the number of eligible participants at the beginning of the plan year. This includes terminated participants with an account balance as well as active participants without a balance. As your count gets closer to 100 participants, you will need to plan for the additional work and expense of becoming a large plan, which is when your Form 5500 requires an accountant’s audit be attached when filed.
  • If you file a Form 5500-SF as a small plan, the 80-120 rule will apply. This means that if your participant count remains under 120, you can continue to file Form 5500-SF as a small plan and do not require an audit. Once your beginning of the plan year count reaches 121, you will then be considered a large plan with an audit requirement.
  • If you are a brand-new plan, though, and have over 100 participants on the first day of the first plan year, the 80-120 rule does not apply and you will require an audit. The 80-120 rule allows you to file as you did the prior year, and new plans do not have a filing for the prior year.

Eligible participants vs active participants with an account balance

  • In addition to tracking eligible participants, the number of active participants with an account balance is also listed. This shows you how many of your eligible active participants have a $0 balance.
  • If your plan provides for your participants to contribute 401k deferrals, automatic enrollment is an option to increase participation. In this case they must opt out, rather than opt in.

Terminated participants with an account balance

  • As this number increases, it is a good time to review the list of terminated participants with account balances. If a participant has an account balance over $5,000, they generally must make a written election in order to withdraw the funds either as a cash distribution or rollover to an IRA or another qualified plan. However, smaller balances may be eligible for automatic payment without the participant’s election if the terms of the plan allow mandatory distributions (these may also be referred to as force-out distributions).
  • If you are getting close to having 100 participants, distributions to terminated participants is one way to help lower the plan’s participant count and avoid the additional expense of being a large plan.

ERISA Fidelity bond coverage amount

  • An ERISA fidelity bond is a type of insurance that protects the plan against losses caused by acts of fraud or dishonesty.
  • The dollar amount of your bond in effect for the plan year is listed on the form. The required coverage amount is the greater of $1,000 or 10% of plan assets as of the first date of the plan year. If less, or listed as $0, it can be a red flag to the DOL.
  • If it is the first year of the plan and the form shows a $0 balance at the start of the year, an estimated asset balance should be used for the 10% calculation when considering the level of coverage for your plan’s bond.
  • In the event you did not establish a bond by the close of the plan year, a bond provider may be able to assist you with a policy that provides retroactive coverage. Some policies can also include an inflation guard going forward so that as plan assets increase, the bond coverage automatically increases to the required amount.
  • Not sure where to obtain a fidelity bond? Your property and casualty insurance agent may be able to add this as a rider to your current business policies or your TPA may be able to provide contact information for a vendor that they have seen in the industry.
  • So, what happens if I don’t have a bond? The correction for not having a bond is to get a bond put in place as soon as possible. However, having an insufficient bond amount noted on the Form 5500 could lead to an IRS or DOL audit where they may review more than just the bond amount.

Late deposits of employee contributions and loan repayments

  • Another red flag to the DOL is the dollar amount of late deposits. There is a safe harbor deposit rule for small plans that states that deferrals and loan repayments must be deposited to the plan no later than the 7th business day following the paycheck date. Large plans have less time with contributions required to be remitted on the earliest date possible instead of within 7 business days.
  • Late employee contributions or loan repayments for the plan year are reported on the Form 5500 or Form 5500-SF. In addition, if the correction for late deposits took place the following year, the amount is reported again on that year’s Form 5500.

Your Form 5500 preparer, often your TPA, will prepare the form on your behalf for your review and signature. They will be able to help guide you through the information that is reported on the form and be sure you understand the information as it reflects on the plan year. The more you understand the Form 5500, the more proactive discussions you can have.