If you have substantial U.S. assets that you want to protect from possible judgments, you may be tempted to use a foreign entity, such as an international business company or offshore trust, to do it. But attorneys are increasingly able to persuade judges to disregard the ownership "form" and seize the property—especially real estate—anyway.
Here's what might happen if you follow this strategy, according to a California attorney I recently spoke to. You own a US$3 million home in Beverly Hills, California, free and clear of any mortgage. The "homestead exemption" in California is at the most US$150,000, which means US$2.85 million of the value of your residence is "up for grabs" by a creditor.
You read on the Internet that a lot of foreigners own property in the United States through a foreign corporation. Since the foreign corporation owns the property in its own name, there's no trail back to "you." That sounds like a good idea, so you form a corporation in the British Virgin Islands and transfer title to your home into it.
A few years later, you get sued. You lose and face a US$5 million judgment. The opposing lawyer subpoenas your tax records for the past five years, including any records relating to foreign financial transactions. The presiding judge orders you to release the records. These documents reveal that you own 100% of the beneficial interest in the foreign corporation that owns your home. They also reveal that several years ago, you transferred the house to the foreign corporation.
With these documents in hand, the opposing lawyer schedules a debtor's exam. "How much rent do you pay for the use of the $3 million home you live in?," he asks. "None," you reply. "Who do you call when there's a problem—the toilet backs up, the roof leaks, whatever?" he asks. "I take care of these problems myself," you reply.
"Do you do anything different now from when you owned the property in your own name?, he asks. You admit that you really don't, other than having the property tax bills sent to the BVI.
The opposing lawyer then submits a motion to the court requesting that the change of ownership be disregarded and that ownership of your home, less the US$150,000 homestead exemption, be transferred to the person who sued you. The judge agrees. You're ordered to vacate the home within 14 days.
How might this nightmare scenario have been avoided? The bottom line is that it's very difficult to protect domestic property—especially real estate—with an offshore structure. It might have helped if you had paid fair market rent to the corporation, although this rent would have been considered taxable income to you. It might have helped also if the foreign corporation had contracted with a property management company that you could have contacted any time there was a problem with the property. But the fundamental problem would have remained—in transferring the property to a foreign corporation you owned, you essentially made a deal with yourself. U.S. courts don't look kindly on these kinds of transactions.
A better way to have protected your home might have been to have mortgaged the property, then placed the mortgage proceeds in an asset protected form—an asset protection trust, a foreign insurance policy, etc. Such "equity stripping" strategies are often far more effective in making a property unattractive to a creditor than in trying to disguise its ownership in a foreign entity.
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