Case Example #2

The next illustration involves a client, Dr. Bell, who owned a valuable medical office building for many years. He had paid about $100,000 for it in 1970 and because of depreciation deductions it had a zero basis for tax purposes. In 1993, when he came to see us, the property had a value of $1 million. He had two principle objectives. First, he wanted to protect this asset from any claims which might arise from his medical practice or personal activities. Second, he wanted to protect himself from any liability associated with the property. He didn't want to get sued because of some problem with the property and risk losing the other assets he had accumulated. He had no pending or threatened lawsuits or other immediate concerns. He was simply interested in developing a prudent business plan.

We felt that these objectives could be accomplished and as a part of his overall plan we put the office building into an LLC. His other assets including his savings were transferred into the Family Limited Partnership. We did not put the office building into the FLP because it is a Dangerous Asset and should not be mixed with Safe Assets.

In 1995, Dr. Bell got involved in some serious business problems because of a partner in a real estate venture. The partner refused to pay his share of the expenses and Dr. Bell was stuck with judgments and bills totaling more than $1 million. The creditor with the judgment attempted to collect from him. Because the office building was in the LLC, the judgment lien did not apply to that property. He was free to sell, refinance, or deal with the property as he decided. His bank accounts and brokerage accounts were safely protected in the FLP. The judgment had virtually no effect on Dr. Bell's accumulated assets because he had engaged in the proper planning.

Compare the difference in this case that resulted from the strategy he used. If he had not put office building in the LLC, the judgment lien would have attached to the property. The creditor would have foreclosed on the property to collect the debt.

For income tax purposes, a foreclosure is treated like a sale for the amount of the debt. In other words, if the creditor had seized the office building, Dr. Bell would have been treated as if he had sold the property for $1 million. His tax basis was zero so the taxable gain would have been $1 million. Not only would he have lost the property with all that equity-he would have been stuck with a tax bill to the IRS of about $300,000.

Instead he managed to shield his valuable assets and continue to defer the taxes on the office building. This is a dramatic example of the advantages which can be obtained by using the correct legal structure to protect valuable assets.