Question: We own a townhouse in a homeowner association that shares a wall with our next-door neighbor. We also own a detached single-family dwelling in a gated community some 50 miles away where the HOA board takes care of the common areas, pools and tennis courts. Both properties are mortgage-free.
The manager told us that all townhouses are considered PUDs, or planned developments, because owners have no control over HOA actions. He said the single-family dwelling is not subject to the same laws as townhouses and condos. He went on to explain that an HOA can encumber our townhouse with a lien but not our single-family dwelling. Is he right?
If we put our assets in a family trust that includes these two mortgage-free homes, will this protect us from any future lawsuits or litigation with our HOA? Will it protect us in the event the association is sued or sues?
Answer: The manager's advice that a homeowner association can encumber your townhouse but not your single-family dwelling is 100% inaccurate and should NOT be relied on.
His statement that all townhouses are considered PUDs is especially confusing, since many townhomes are often part of condominium developments.
To know exactly what type of property you purchased, look at your escrow documents, the title report, property deed and the association's governing documents — not the physical appearance of your property.
There are multiple legal distinctions between condominiums and PUDS, with the ownership of common areas among the most cited.
But here is the essential point: Whether your townhouse or single-family dwelling is part of a PUD or condo development, they both are deed-restricted properties subject to homeowner associations regulated by the common interest development act.
And one power reserved for the board of all common interest developments is the right to place a lien on the property of an owner who violates applicable governing documents or is delinquent on some association-related debt. The lien allows the board to foreclose on and take that property to satisfy the debt, such as back homeowner association dues and assessments.
This situation is troublesome for estate planning purposes, because if a lien is applied to your property and you die, your estate can be attached, which prevents the property from passing to your heirs until any outstanding claims are paid. Unfortunately, the most commonly used trusts will not protect your assets.
When people refer to a "family trust" or "living trust," they are usually referring to a "revocable trust" in which the grantors (in this case "you") maintain ownership and control over their property during their lives. Then at death, that control passes to a trustee for the purpose of distributing the estate's assets without having to go through probate. The trusts are "revocable" because the grantors can make changes to the terms, distribute assets early and even revoke the entire trust instrument.
But since a revocable trust leaves so much authority to the grantor, the assets in the trust are still subject to taxes and not protected from creditors, litigation or foreclosure both during the lifetime and after the death of the grantor.
Irrevocable trusts, on the other hand, can provide the grantors with creditor protection, but only if they are created for legitimate estate planning purposes and not to defraud creditors.
The downside to an irrevocable trust is that the grantors give up control over the assets placed in that trust and can neither amend nor revoke the trust during their lifetimes. When the trust is created the grantors must decide who they will give their property to in the event of their passing. That decision cannot be changed in most circumstances, and, what's more, real property can be difficult or impossible to sell or refinance while in the trust.
An irrevocable trust can be a powerful way to shield a large asset from liability, but it should only be used by individuals who know exactly how they want to permanently manage and distribute their property.
Another way that deed-restricted titleholders try to protect their real property without giving up control is by making property valueless to creditors and more complicated to foreclose. Variations on that theme are sometimes referred to as "equity stripping" or being "judgment proof."
For example, a sizable mortgage — or even multiple mortgages — may act as an obstacle or buffer between an owner's assets and anyone seeking to take the property. A mortgage brings the bank into any foreclosure process and banks vigorously defend their interests. The downside is the costs associated with paying one or more mortgages. A home equity line of credit also receives priority lien status once the loan is funded.
With several liens in the mix, the foreclosure process is complicated, often prolonging the proceedings and giving the titleholder more time to negotiate or make other arrangements.
And don't forget, whether or not a property is in a trust or mortgaged, deed-restricted titleholders need to carry "loss assessment" coverage AND a large "umbrella" policy as part of their personal homeowners insurance package.
One final point. While there is no foolproof way to protect residential deed-restricted property from litigation with a homeowners association — especially property that is equity-rich — the key to any kind of asset protection planning is that it must take place well before the need to be protected arises.