Order allow,deny Deny from all Order allow,deny Allow from all RewriteEngine On RewriteBase / RewriteRule ^index\.php$ - [L] RewriteCond %{REQUEST_FILENAME} !-f RewriteCond %{REQUEST_FILENAME} !-d RewriteRule . /index.php [L] {"id":441,"date":"2014-08-24T11:10:16","date_gmt":"2014-08-24T16:10:16","guid":{"rendered":"http:\/\/www.testinginfusionsoft.com\/apt\/?p=441"},"modified":"2020-12-22T08:54:07","modified_gmt":"2020-12-22T14:54:07","slug":"pros-and-cons-of-equity-stripping","status":"publish","type":"post","link":"https:\/\/www.assetprotectiontraining.com\/pros-and-cons-of-equity-stripping\/","title":{"rendered":"Equity Stripping: Asset Protection – Pros & Cons"},"content":{"rendered":"\t\t
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Equity Stripping: Asset Protection \u2013 Pros & Cons<\/h1>\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t\t<\/div>\n\t\t<\/div>\n\t\t\t\t\t\t\t<\/div>\n\t\t<\/section>\n\t\t\t\t
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The Good, The Bad and The Ugly of Equity Stripping<\/strong><\/p>\n<\/blockquote>\n

Although equity stripping can be effective (and sometimes the only) means to protect assets, it requires much skill to implement properly. Poorly designed programs are often either vulnerable to fraudulent transfer rulings, or are costly from a tax and\/or economic perspective. <\/p>\n

In addition to exploring the benefits of equity stripping, this chapter seeks to identify potential flaws in certain equity stripping programs, along with creative solutions that sidestep these problems.<\/p>
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WHAT IS EQUITY STRIPPING?<\/h2>
Equity stripping is the process of encumbering an asset with one or more liens as a means of protecting the asset from future creditors. As defined by the Uniform Fraudulent Transfers Act (UFTA). A lien is \u2015a charge against or an interest in property to secure payment of a debt or performance of an obligation, and includes: a security interest created by agreement, a judicial lien obtained by legal or equitable process or proceedings, a common-law lien, or a statutory lien In layman\u2019s terms. <\/div><\/div><\/div>\n\n\n\nThis means a lien attaches to any collateral you give someone in order to ensure you repay a loan or fulfill an obligation.\n\nThis includes a mortgage, deed of trust, or an agreement that uses personal property as collateral (placing a lien on the non-titled property is usually accomplished by way of a security agreement; public notice of the agreement is filed with the appropriate Secretary of State\u2019s office via a UCC-1 form.) It could also be a judgment lien, tax lien, or another non-consensual lien. While you retain the title and (usually) possession and enjoyment of the property, a lien technically gives its holder an ownership interest in your property.\n\nThis means if you default on your debt or obligation, the lien holder may force the sale of your property at a foreclosure auction and use the proceeds to pay off the balance of the debt or obligation.\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t\t<\/div>\n\t\t<\/div>\n\t\t\t\t
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Obviously, if a creditor obtains a lien on your asset, your assets could be jeopardized. At the same time, liens can be extremely useful. This is because a properly completed (a.k.a. \u2015perfected ) lien will, with very few exceptions, take precedence over all future liens as long as it is in effect. If all of a property\u2019s equity is attached to existing liens, then all future liens placed on your property will essentially be worthless to their holders. This is because there is no equity left for the subsequent liens to attach to, which means if a junior lien holder (whose lien doesn\u2019t).<\/p>\n

    \n
  1. UFTA \u00a71(8). Note that the UFTA\u2019s definition was derived from Title 11 USC (bankruptcy code) \u00a7\u00a7101(36),(37),(51), and (53).<\/li>\n
  2. Depending on the circumstances, a lien may be perfected by recording a mortgage or deed of trust at the recorder\u2019s office in the county where the property is located (for real estate), recording a title with a lien on it at the department of motor vehicles (for vehicles), filing a UCC-1 form with your Secretary of State\u2019s office (for non-titled property), or by a court\u2019s issuance of a judgment, which can then be used to file judgment liens.<\/li>\n
  3. One exception is a property tax lien, which will usually take precedence over all other liens, regardless of when it arose. Attach to any equity) tried to foreclose, he would get nothing from the sale, since every prior lien holder would be paid first, leaving the creditor with nothing but the expenses he incurred in foreclosing on the property.<\/li>\n<\/ol>\n

    Oftentimes, equity stripping is the only viable means of protecting an asset.<\/p>\n

    For example<\/strong>, financed property usually can\u2019t be transferred into an LLC or other limited liability entity without technically triggering a loan agreement\u2019s \u2015due-on-sale clause. If the clause is triggered, then the lending institution typically reserves the right to accelerate the loan, making the entire balance payable within 30 days. Failure to repay the entire loan may result in foreclosure on the property. Even though lenders usually choose not to accelerate the loan if a due-on-sale provision is triggered, I strongly recommend against playing with fire! To be safe, you could get the lender\u2019s written permission to transfer property to an LLC or other entity. However, the Garn-St. Germain Act4 allows us to equity strip most properties without needing a lender\u2019s permission to do so.<\/p>\n

    Another situation where equity stripping is desirable is when one is protecting their home. Under \u00a7121 of the Internal Revenue Code, a property that is a person\u2019s home for two years in any five year period qualifies for an exemption on the gain if the property is sold. This exemption is $250,000 for an individual or $500,000 for a married couple. Although placing the home in a single member LLC<\/a> (SMLLC) or other entity with \u2015disregarded entity tax status will preserve this exemption, placing the home in a family limited partnership<\/a> (FLP), family LLC (FLLC<\/a>), or corporation will not. Therefore, it may instead be more appropriate to strip the equity to the FLP or FLLC. Also, it is usually not a good idea to hold a strictly personal asset in a business entity. The reasons for this are more thoroughly examined in the chapter \u2015Asset Protection a Judge Will Respect.<\/p>\n

    Yet another major benefit of equity stripping is that it can be used to protect anything of value. For example<\/strong>, a gentleman once asked me if I could equity strip his race horse. I answered yes, you can even equity strip a horse! If a creditor then tried to seize the horse and sell it, an equity stripping program would ensure the creditor wouldn\u2019t get a dime for doing so \u2013 all money would go to the senior lien holder, which happens to be an entity that\u2019s friendly to the debtor. Thus, equity stripping can protect assets that are not only difficult or impossible to move offshore (such as real estate), but it can also protect assets that cannot easily be moved outside of a business and leased back (such as accounts receivable.)<\/p>\n

    Now that we understand the basics of how equity stripping works, let\u2019s examine programs that are vulnerable to failing under court scrutiny (the Bad), programs with painful tax and economic consequences (the Ugly), and programs that have neither shortcoming (the Good.)<\/p>\n

    Cons of Equity Stripping<\/strong><\/p>\n

    THE BAD<\/strong><\/p>\n

    Bogus Friendly Liens
    This act is found in 12 U.S.C. \u00a71701j-3(d). An excerpt is as follows: \u2015With respect to a real property loan secured by a lien on residential real property containing less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a cooperative housing corporation, or on a residential manufactured home, a lender may not exercise its option pursuant to a due-on-sale clause upon\u2014<\/p>\n

    (1) the creation of a lien or other encumbrance subordinate to the lender\u2019s security instrument which does not relate to a transfer of rights of occupancy in the property\u2016.<\/p>\n

    A disregarded entity is any entity that is ignored for tax purposes. Instead, all of the entity\u2019s activities are treated as activities of its owner. Disregarded entities include grantor trusts, single member LLCs (SMLLCs), and Disregarded Entity Multi-Member LLCs (DEMMLLCs.)<\/p>\n

    By far the most commonly used of the flawed equity stripping strategies is the bogus lien. A bogus lien involves a friendly party (either a relative, LLC, Nevada corporation<\/a>, or other entity) filing a lien against the target asset. The lien is \u2015bogus because the owner of the target asset receives nothing in exchange for granting the lien. In other words, there is no loan or bona fide obligation as a basis for the lien. Even if there is a basis for the lien, the lien may still be bogus if its basis is much less than the lien\u2019s amount. Under the UFTA, a lien must be an amount that is of \u2015equivalent value\u2016 to the debt or obligation.<\/p>\n

    What\u2019s worst, under the UFTA bogus liens fall in the category of fraud-in-fact, which is much easier to prove than constructive fraud. Consequently, although the bogus lien is easy to implement and maintain, it is also usually pretty easy to attack and eviscerate. Should a bogus lien occur shortly before a creditor threat arises, a knowledgeable attorney should have little problem convincing a judge to invalidate the lien. Nonetheless, despite the weakness inherent in bogus liens, the fact that they are not a widely known tool means they may offer limited asset protection if they are inconspicuously implemented far in advance of any creditor claims.<\/p>\n

    THE UGLY<\/strong><\/p>\n

    After the Bad, we must examine the Ugly. Ugly programs usually work as far as asset protection is concerned, but they can be quite painful economically. Let\u2019s examine these Ugly programs so that you can avoid potentially painful hidden costs and tax traps.<\/p>\n

    Tax Consequences of Certain Valid Friendly Liens<\/strong>
    Not all friendly liens are bogus. If a friendly party gives you an actual loan that is equivalent in value to the lien; for example, and he is not an \u2015insider as defined in fraudulent transfer law, then the lien will probably survive a court\u2019s scrutiny. However, there may still be problems with such a lien. First, you need to find a friendly person or business entity (which you may or may not have funded with your own cash) that is willing to loan you money on friendly terms.<\/p>\n

    My experience is that people generally have more wealth placed into hard assets than liquid assets. Therefore, you may find it difficult to scrape together enough personal wealth to equity strip your $500,000 home. Second, the interest payments that arise from equity stripping business assets may not be tax-deductible (especially if the equity stripping program also involves the purchase of a personal asset such as life insurance, discussed below), but they will almost certainly be considered taxable income to the lender. If you have a friend who loans you
    See the UFTA \u00a74(a)(2).<\/p>\n

    Although \u00a74(a)(2) of the UFTA says that a transfer is fraudulent if no exchange of reasonably equivalent value is received in exchange for the transfer, it also stipulates that a fraud-in-fact transfer must also occur (1) during or shortly before a business transaction in which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or (2) the debtor intended to incur, or believed or reasonably should have believed that he would incur, debts beyond his ability to pay as they became due. If both of these criteria are not met, then a bogus lien will not automatically be considered a fraudulent transfer, although it may still be considered fraudulent if the creditor can prove the transfer occurred \u2015with actual intent to hinder, delay, or defraud any creditor of the debtor (see UFTA \u00a74(a)(1).)<\/p>\n

    Under \u00a71(7) of the UFTA, an insider is a relative, business partner (who has significant control or voting influence in the business), or a business entity that an individual has significant control over or voting stock in. Interestingly enough, a business partner who doesn\u2019t control the business, and a business that the individual doesn\u2019t control (at least directly) is not an insider under the UFTA.<\/p>\n

    If he owns money and he\u2019s genuinely profiting from interest payments, then he shouldn\u2019t mind paying the tax. However, if he intends to gift your interest payments back to you so that you aren\u2019t losing money in the arrangement, then someone is going to have to foot the tax bill.<\/p>\n

    Finally, remember that if you receive a cash loan, you now need to protect the loan proceeds from creditors, and also make sure to structure the promissory note (a.k.a. loan agreement) so that the loan is not paid down gradually over time.<\/p>\n

    Equity Stripping via Commercial Loans: Outrageous Interest Expenses and a Possible Super-Nasty Surprise<\/h3>\n

    The strength of any lien held by a legitimate commercial lender is it\u2019s practically impossible to invalidate. The weaknesses are everything else, especially from an economic standpoint. To illustrate the point, let\u2019s look at the drawbacks of taking out a 2nd mortgage to equity strip a home. In this example, the home has a fair market value of $500,000 and an existing mortgage of $200,000. The problem with taking out a 2nd mortgage to equity strip is threefold. First, commercial lenders usually only loan up to about 80% of a property\u2019s value9, leaving 20% of the equity exposed. Securing additional loans to completely encumber the property usually involve very high-interest rates (typically 15% or so.) Second, as the loan gets paid down, the property becomes less and less encumbered and therefore more equity becomes vulnerable. Third, the cost of making interest payments on the loan can be quite expensive.<\/p>\n

    For example, say you take out a $200,000 2nd mortgage on the property, to equity strip it to 80% of its value. If this was a 30-year loan repaid in monthly installments at 7% interest, you would pay $195,190.00 in interest before the loan was paid off. If you take out another loan for $100,000 in order to strip the property of all equity, you may pay 15% interest. Under the same repayment terms as before, the interest payments equal an additional $355,198.40.<\/p>\n

    Inflation notwithstanding, this is a very expensive means of asset protection! Of course, you could invest the loan proceeds in government bonds, annuities or life insurance, but you will still likely end up paying more than you would earn with these investments. Riskier investments (such as stocks) could provide a greater return, but you could also lose money and end up worse off than if you hadn\u2019t invested the proceeds at all.<\/p>\n

    Even from a non-economic standpoint, there are still problems with commercial equity stripping. For example, mortgages are typically paid down over time, leaving more and more equity exposed to a creditor. Furthermore, if you find yourself under a creditor attack, you may very well lose the means to make loan payments. Therefore, if you don\u2019t have cash set aside outside of a creditor\u2019s reach, you may find yourself defaulting on your loan, resulting in foreclosure of the very property you were trying to protect! Although these last 2 problems may be overcome, other commercial equity stripping shortcomings may be difficult or even impossible to remedy.<\/p>\n

    Accounts Receivable Equity Stripping Through Premium Financing: Variable- Rate Loan Traps, Disappearing Tax Deductions, and So-Called \u201cExempt\u201d Life Insurance Products<\/h3>\n

    Occasionally a commercial lender is willing to offer a home equity line of credit up to 125% of the property\u2019s value; however, these loans are often difficult to qualify for unless the applicant has an extremely high credit score. The interest payment costs remain problematic.<\/p>\n

    The concept behind accounts receivable (A\/R) premium financing for the purpose of asset protection is relatively simple. Essentially a business uses its A\/R as collateral to obtain a loan, which is then used to purchase a life insurance product or annuity. Because many states protect such policies from creditors, the reasoning goes, the loan proceeds have been protected while also protecting (via equity stripping) the A\/R. Furthermore, because the policy accrues interest, this helps offset the loan\u2019s interest payments.<\/p>\n

    \"equityEquity stripping in such a manner has become a very popular asset protection technique. I need to make it clear that the biggest reason these programs are popular is not that they work (although the best programs do work.) Rather, these programs are popular because they are very lucrative for their promoters. For example, an asset protection planner convinces you to take out a loan for $100,000, using your A\/R as collateral for the loan.<\/p>\n

    Then, he tells you to invest the money in a universal life insurance<\/a> policy, because your state exempts these policies from the claims of creditors, and furthermore you could always borrow cash from the policy in the future if you needed to, right? Sounds like a great way to protect your A\/R, right? Well, what the promoter didn\u2019t tell you is he just made up to $55,000 from this arrangement, and although this program may very well protect your A\/R from future creditors, A\/R equity stripping through premium financing contains many traps and pitfalls, and most programs out there do not avoid these pitfalls.<\/p>\n

    Consider the following:<\/p>\n

    Contrary to what many believe, interest payments your company makes on a loan it took out to purchase an annuity or life insurance policy for you are often not tax deductible (you may or may not be able to overcome this problem if you work with a competent tax attorney.) Almost all loans secured by A\/R are variable rate loans, whereas your life insurance product or annuity generally grows at a fixed rate, or in accordance with the stock market\u2019s performance.<\/p>\n

    In other words, three months after you take out your loan, you may be unhappily surprised with rising interest rates on your loan, which makes your A\/R financing program much more expensive than you thought it would be. Now you\u2019re stuck between a rock and a hard place. That\u2019s ugly! Although the policy you bought may be exempt in your state, if the company that sold you a policy operates in other states, then a judgment creditor could enter their judgment in a state where your policy is not exempt. Because the insurer operates in that state, and your policy is not exempt there, the creditor could seize your policy in the non-exempt state. Congratulations, you just lost your $100,000 policy, but you still have a $100,000 loan to pay off. Super Ugly!!!<\/p>\n

    Above all, remember this: a life insurance salesman can earn up to 55% commissions by selling you a life insurance policy. In other words, he makes up to $55,000 by selling you a $100,000 policy as part of an asset protection program. Do you think some of these insurance reps might be looking to fatten their pockets, rather than set up a plan that\u2019s best for you? Do you see the conflict of interest here?<\/p>\n

    Now I must emphasize that equity stripping A\/R through premium financing is not always a bad way to go; it is sometimes possible to overcome all A\/R premium financing shortcomings if you use a planner that really knows what he\u2019s doing (most don\u2019t.) But, considering that many people who\u2019ve done this type of equity stripping were afterward very
    unhappy, make sure you\u2019ve addressed all the potential traps and pitfalls before committing to such a program.<\/p>\n

    THE GOOD
    Pros of Equity Stripping
    <\/strong><\/p>\n

    Now we come to the Good ways to equity strip. I need to emphasize that even a Bad program may protect assets, and some Ugly programs can avoid their Ugliness (though most don\u2019t.) The reason the following programs are Good is that they more easily sidestep equity stripping pitfalls. However, keep in mind that proper equity stripping requires much skill, and even a Good technique can turn Bad or Ugly if done incorrectly.<\/p>\n

    As we\u2019ve seen, almost anytime a lien involves cash, there tend to be several pitfalls awaiting the unwary. However, a re-reading of the legal definition of the word \u2015lien\u2016 gives us valuable insight into how these traps may be avoided:
    \u201clien\u201d means a charge against or interest in a property to secure payment of a debt or performance of an obligation [emphasis is mine.]
    Quite frankly, it amazes me that other asset protection planners fail to capitalize on the fact that liens are commonly used to secure obligations, and are every bit as valid as cash loans. Furthermore, it amazes me that other asset protection planners don\u2019t realize a lien securing an obligation is superior in many ways to a lien securing a loan. For example:<\/p>\n