In the world of asset protection planning there are times when it is advantageous to hold a personal residence in a limited liability company. Generally, such a situation would be applicable where there is a client who wishes to protect a valuable asset from future unknown creditors, the conveyance to the LLC is not a fraudulent transfer, the desire to obtain creditor protection trumps the loss of any property tax benefit otherwise available to a principal residence, and the client accepts certain complexities that go along with the transaction. For example, the client will need to enter into a lease with the LLC upon arms length terms in order to avoid the LLC being deemed the alter ego of the client which would likely nullify any creditor protection benefits.
A recent Sixth Circuit Bankruptcy Appellate Panel decision points out why it can be a major disadvantage for a debtor to hold title to the debtor’s residence in an LLC. In In Re Breece, the Panel held that a debtor who filed a Chapter 7 Bankruptcy Petition could not exempt from the bankruptcy estate the property owned by her 100% owned LLC even though she used the property as her principal residence. The parties acknowledged that if the debtor had owned title to the property in her own name when she filed her Chapter 7 Petition, the property would have been entitled to an exemption under Ohio law (Ohio has elected to opt-out of the federal exemptions and create its own). So the sole issue to be decided in the case was whether the debtor’s ownership of the LLC, which owned the home, entitled her to claim the exemption.
The debtor relied on the homestead exemption in the Ohio Revised Code providing that a person residing in Ohio may hold exempt from execution, garnishment, attachment or sale to satisfy a judgment such person’s interest in a parcel of real property used by the person or her dependent as a residence up to a value of $21,625. The analysis undertaken by the Panel proceeded to show that the debtor did not have the requisite interest in the property to permit application of the exemption; instead, the Panel found that she only held an interest in a limited liability company which in turn owned the subject property. Asset protection planning attorneys and pre-bankruptcy planning attorneys need to be careful to avoid this situation.
The Panel went through a detailed analysis of limited liability company law in Ohio and observed that a member of an LLC does not have any interest in the LLC’s personal or real property. Such property is instead owned by the LLC. The Panel then discussed the law regarding corporations and other business entities and how their separate existence is a hallmark of business law absent fraud or bad acts by the shareholders that warrants piercing the corporate veil. As the law evolved the same distinct existence concept was bestowed upon limited liability companies. The Panel could find no basis upon which it could ignore the LLC’s ownership of the property and treat the property as being owned by the debtor.
What is not stated in the case is how the Chapter 7 Trustee benefited from its victory in this case. Wouldn’t the debtor claim that the Trustee cannot reach the equity in the home in any event because the property is owned by a limited liability company and therefore the Trustee would only be entitled to a charging order? Merely speculating now, but the Trustee may have already concluded that the bankruptcy estate would be able to reach the property based on an alter ego theory (the debtor ignored the separate existence of the LLC, did not pay rent, commingled assets) and therefore the LLC should be ignored.