While this website is about the Islamic rules of inheritance, a common goal for many families is to safeguard their assets, and their residence, if they get sued or some other financial calamity comes around.
I will focus very much on other assets here (I am sure I will write about them later), but rather, we will discuss the family home.
California is a creditor-friendly state. What I mean by that is that California law tends to be raked to favor creditors whenever possible, including when it comes to the personal residence. So if you have some money, or, more importantly, equity in a home, and there is somebody that you owe money because of a court judgment, that person will probably be able to take that money, and that means making you leave your home.
Now if you had done a revocable living trust consistent with the Islamic rules of inheritance (and you should) one thing that does not happen is any asset protection at all, at least while you are alive. Your assets have the same level of protection from lawsuits that they would have had without doing a revocable living trust. You do it for other purposes, such as inheritance and incapacity planning.
Now obviously, you do not want to leave your home. Now if you had some cash, a business or other assets, there are a broad range of asset protection planning opportunities that you can use. Some of them may be in California, some of them would be outside of California. However, the home has a very limited level of protection, something called the homestead exemption.
About the homestead exemption
For most California homeowners, the homestead exemption is quite small. It ranges from $75,000 for single people to $150,000 for the elderly on a limited income. What this means is once you get evicted from your home, you get to keep a limited amount of the money that comes from the equity in that home. The rest of it goes to the creditor.
If you have accumulated significant equity in your home, like many California families, the homestead exemption offers inadequate security.
Out of State Trusts
One other option is placing the home in a trust in a jurisdiction that provides asset protection. If you have a home in California, this may or may not work. It may not work because the home is on property in California, and theoretically a judge can just transfer the property over to the creditor. Of course, if you have assets that are not in the reach of a California judge, this could be a good option, though with some caveats that are outside of the scope of this post.
Another method some people have heard about involves a process of stripping the equity from your home into an out-of-state entity. So you are creating the out-of-state entity, however, having a judge transfer the property over to a creditor would not do much, since there is no equity in it. The problem with this tactic is that it typically involves getting a commercial loan. Loaning the money to yourself, even through a business entity, is not likely to work. There would be a deed of trust that evidences this loan. The idea is that a judge cannot simply undo a deed of trust that is held by a commercial lender you don’t own or control.
The cash that came from the proceeds of the loan may be somewhere safer than California. The person who took out this loan pays it back, with interest. Of course, the money can be invested in something that potentially pays a better return than the interest rate. However, given that this is a post meant for Muslims, we need to discuss the elephant in the room, interest.
While many people will take out interest-based loans for their mortgages and can perhaps even point to fatwas that say it is fine for them to do this, while others will disagree, we are still dealing with interest. Now, it is possible that someone can get a sharia-compliant loan and do this procedure, there won’t be a problem. However, there are no scholarly opinions that say an interest based loan for an asset protection plan based on equity stripping is halal. A major downside is you need to always be in debt. Maybe you don’t mind, which is fine.
So, equity stripping is a real option for many people, even Muslims. Just use a sharia-compliant lender. It does not protect the home per say but makes it far less likely anyone would want it.
Qualified Personal Residence Trust
This is another option for protecting the home without getting a loan. It is far less complicated, though there is a (small) cost. After a few decades, you end up paying rent to your children.
The way this works is that you get a trust that splits the interest in your property with you holding it for a period of years (you determine the number of years) and in the remainder, goes to a trust for the benefit of your children. It does not go directly to your children but stays in trust. If you survive past the number of years that you have designated, you need to pay fair market value rent.
This method, which is primarily designed for estate tax planning, is effective because an asset that is only yours for a period of years is not especially attractive. They would not know what to do with that. Now if your children were sued, it would not affect you or them. The beneficiary is a trust, remember. It is not your children directly.
There are hundreds of thousands of lawsuits in the United States every year. If you are a business owner, a physician or if you have any regular interactions with people where you may be subject to lawsuits, you do want to make sure that you do whatever it is that you can to protect your home for yourself and for your family. Of course, you do all of this keeping in mind Islamic rights and ethics.