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A farm homestead

Does your homestead exemption achieve your planning goals?

by Curtis Lee | Contributor
April 7, 2020

The homestead exemption provides the two main benefits of asset protection and property tax reduction. However, placing a home in a trust could jeopardize some of those benefits.

The homestead exemption is one of the most popular and widely used legal constructs to help reduce property taxes and protect property from creditors. It can also provide shelter to individuals who can't otherwise afford to live in their home such as after the death of a spouse.

So using the homestead exemption seems like a logical move, and for many people it is. But as with many other things with the law, finance and taxes, there are exceptions and caveats to be aware of. The purpose of this article is to discuss a few of these, such as when putting a homestead exempted property into a revocable living trust.

What is a homestead exemption?

A homestead exemption is a legal framework that protects a primary residence from:

  • Certain types of creditors
  • Higher property taxes
  • A forced sale when the owner is suffering from financial hardship

For the most part, homestead exemptions originate at the state level. This means how they work will depend on each state's laws. Most states offer homestead exemptions, but some of these states limit its availability.

States that offer homestead exemptions and/or credits, but with limitations
State Type of Limitation
Connecticut Only available to certain population groups
Delaware Not available statewide
Michigan Only available to certain population groups
Nevada Only available to certain population groups
Oregon Only available to certain population groups
Pennsylvania Not available statewide
Rhode Island Only available to certain population groups
South Dakota Only available to certain population groups
Vermont Only available to certain population groups

Basically, the two biggest advantages of a homestead exemption are that it can help keep a home safe from some creditors and it can lower or eliminate property taxes.

The homestead exemption for asset protection

Each state will be different in how the homestead exemption works. However, it often works by protecting a certain amount of equity the homeowner has in their home. The amount of equity protected will vary from state to state, but can typically range from $15,000 to $100,000.

Ironically, the more equity someone has in a home, the less likely the homestead exemption will protect it from certain creditors. That's because in many states, if the homeowner's equity in the property exceeds the protection limit, then an eligible creditor can force the home to be sold. Any proceeds that are left after paying off the debt will remain with the homeowner.

The protection will not apply to secured creditors, who have the home itself as collateral for a debt. This means a bank that holds a mortgage on the home can still force the property to be sold even with a homestead exemption in place.

The homestead exemption for property tax reduction

The property tax benefit may be the single biggest reason why most people like taking advantage of the homestead exemption. States that offer the homestead exemption will typically reduce a home's value that's subject to a property tax by a certain percentage or amount.

For example, let's say you have a home worth $100,000 and it's subject to a 1% property tax. Let's also assume the home is in a state that provides a $75,000 homestead exemption. This means that the property tax is 1% on $25,000 as opposed to 1% on $100,000. So instead of paying $1,000 each year in property taxes, the homeowner only has to pay $250.

One thing to keep in mind is that a few states will only offer this tax benefit to certain types of homeowners, such as those over a certain age.

Potential pitfalls with the homestead exemption

The homestead exemption sounds nice, and it is. But to keep these benefits, the person taking the homestead exemption needs to keep a few things in mind.

First, the property needs to be a primary residence. If the homeowner moves to another property, the homestead exemption may be lost.

Second, the property cannot earn income. Depending on the state, if the home serves as a rental property, a portion of the home subject to rent could result in a partial reduction in the homestead exemption.

Third, changing the legal ownership of the home could forfeit the exemption. The homestead exemption belongs to the owner, not the property itself. So if there is a new owner, then the exemption is lost. This is very important to keep in mind in the case of placing the homestead exempt property into a trust.

What is a trust?

A trust is a special legal arrangement where property is transferred by one person (the trustor or settlor) to a second person (the trustee), for the benefit of a third person (the beneficiary). One of the advantages of a trust is that property held in certain types of trusts can bypass the probate process. However, only certain trusts can do this, specifically, a living trust. A living trust is a trust that's created during an individual's lifetime, as opposed to a person's death.

Photo of a model house on a desk

One of the most popular types of living trusts is the revocable living trust (RLT). Personal homes are often placed into an RLT to make it easier to manage as an asset and to avoid the probate process.

The problem with RLTs is that they can sometimes eliminate or reduce the homestead exemption's benefits. In some states, placing a homestead exemption property into an RLT may eliminate the homestead exemption. In other states, the exemption can remain, but only if either the trustor/settlor or the beneficiary has the legal right to live in the home as a primary residence at no cost to them.

But even if the homestead exemption remains, some of its benefits may not. For instance, a homestead exempted home held in an RLT may continue to receive property tax benefits, but may no longer receive protection from unsecured creditors.

The bottom line about homestead exemptions

Homestead exemptions are state-specific and things can get even more complicated when you add things like a bankruptcy proceeding or place the property in a trust. Therefore, it's imperative that anyone looking into getting a homestead exemption or placing a home into an RLT, talks to an experienced estate planning attorney first.

A lawyer will be able to not only obtain the homestead exemption, but also make sure it's in line with a person's overall estate planning needs and goals.

How do I create an estate plan?

There are numerous options and scenarios to consider when developing an estate plan that protects your legacy and achieves your objectives, and important decisions should be made with the advice of qualified lawyers and financial experts. Membership with Legacy Assurance Plan provides members with valuable resources and guidance to develop comprehensive estate plans that take life's contingencies into consideration and leave a positive impact for generations to come. Legacy Assurance Plan members also receive peace of mind that a team of trusted, experienced professionals will assist them in developing legal, financial and tax strategies that will meet their needs today and for years to come through periodic reviews.

This article is published by Legacy Assurance Plan and is intended for general informational purposes only. Some information may not apply to your situation. It does not, nor is it intended, to constitute legal advice. You should consult with an attorney regarding any specific questions about probate, living probate or other estate planning matters. Legacy Assurance Plan is an estate planning services company and is not a lawyer or law firm and is not engaged in the practice of law. For more information about this and other estate planning matters visit our website at legacyassuranceplan.com.

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