#creditorprotection

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 1^st 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   

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COVID has impacted us all and unfortunately forced many individuals to be laid off or business owners to close their doors.  As relief runs out and with no further relief in sight it is expected that bankruptcy filings will increase in 2021. The good news is that there is protection for people’s retirement accounts, but the coverage varies depending on state law and the type of retirement account. This coverage means in the event of bankruptcy your retirement accounts are protected and can’t be touched by creditors.

Bankruptcy

401(k), 403(b), and 457 plans

Plans under Employment Retirement Income Security Act (ERISA) are protected from garnishment or levy from creditors. Retirement accounts under this protection include most 401(k), 403(b), and government 457 plans. Some types of 403(b) plans provided by government or churches may be exempt from ERISA.

Traditional IRA and Roth IRA accounts

Under the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) creditor protection is provided for Traditional and Roth IRAs. The BAPCPA provides protection in the case of bankruptcy up to $1 million indexed for inflation ($1, 362,800).

Rollover IRA accounts

Under BAPCPA funds rolled over from a 401(k), 403(b), and government 457 plan accounts are completely protected, and the full amount is protected in bankruptcy

Inherited IRA accounts

Unfortunately, the Supreme Court has ruled that Inherited IRAs are not protected under BAPCPA in Clark v Rameker.

Creditor Protection

401(k), 403(b), and 457 plans (*that are ERISA plans)

Protection for retirement accounts can go beyond just bankruptcy. For ERISA plans they are fully protected just like bankruptcy EXCEPT for qualified domestic relation orders (QDRO) for divorce and IRS levies. Please be aware these protections apply to plans that are under ERISA and non-ERISA plans do not have the same protections.

Non-ERISA Accounts

There is no federal protection for Traditional IRA or Roth IRA. Instead, creditor protection is provided at the state level and varies. Each state has its own rules on creditor protection, and they can vary. On top of that, some states have different creditor rules for Traditional IRA and Roth IRA accounts.  For example, in California, a Roth IRA has no protection but in a Traditional IRA only the “amount necessary for support” is safe and the judge determines what this amount is. If you are doing a rollover an important consideration is if there is a potential need for creditor and bankruptcy protection. If this is the case keeping the assets in an ERISA plan is the best way to go.