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Asset Protection – Single Entity – (con’t) The charging order is one, and possibly the sole remedy in some
states. Other states allow foreclosure
on the partnership interest as well.
Some states allow foreclosure by statute and others by case law. It has long been questioned whether or not the limited partnership is
the correct vehicle to protect the personal residence. There has been
uncertainty whether a partner in a limited partnership may deduct mortgage
interest under Code Section 163 (h) (3).
Many different tax authorities interpret the Code different ways. One book will say that it is permissible to
deduct mortgage interest for personal residence held in a limited
partnership, while another book written by different tax authority will take
the opposite view. Also, under section
121, it appears that only an individual or grantor trust would be entitle to
be excluded from gross income up to $500,000 from the sale of a personal
residence. Married people are willing
to put their homes in a limited partnership and risk losing the mortgage
interest deduction because they feel it is better to deal with the IRS than
risk having their home taken from them by a creditor. People are willing to wait until the legal
crises has passed, and then deed the property back into their own name for a
couple of years, then sell the property and thus qualify for the $500,000
exemption. The non-entity single member LLC can be a solution to these concerns.
Under Treasury Reg. 301.7701-3 a wholly-owned LLC can “check the box” so as
to be taxed as a non-entity. This
single member LLC would be disregarded for tax purposes and taxed as if the
individual owns the asset. Most states
now allow one person LLC’s. Since
LLC’s have all of the charging order protection that was mentioned
previously, this allows the creditor to have the best of both worlds. They can deduct mortgage interest and
qualify for the exclusion, as well as having charging order protection. Under this scenario a married couple would have two choices. They can transfer the home into a single
entity LLC and have that entity owned by the least risky spouse; they can
form two single entity LLC’s and have each spouse own one of them. Then, they can have each single entity LLC
hold a 50% interest in the property.
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