California law allows homeowners to protect a certain amount of equity in their homes from if they are sued or file for bankruptcy.
According to the California Lawyers Association, the homestead exemption was first signed into California law in 1851, and the exemption amount has been adjusted multiple times in the last 170 years. The rationale behind the law is that the home is a critical component to the healthy function of a family unit. Case law from the early 1900's provided:
“The object of all homestead legislation is to provide a place for the family and its surviving members, where they may reside and enjoy the comforts of a home, freed from any anxiety that it may be taken from them against their will, either by reason of their own necessity or improvidence, or from the importunity of their creditors.” Thorsby v. Babcock, 36 Cal.2d 202, 204 (1950), quoting In re Estate of Fath, 132 Cal. 609, 613 (1901).
Former Homestead Exemption Didn't Keep Pace With Current Home Values
Up until recently, the amount of equity that was exempt under the law was very low. Forbes described it as "terribly antiquated," in that it only protects $75,000 for a single homeowner, and to up to $175,000 for a married elderly couple. Those figures may have protected the full value of a median priced home 45 years ago; however, according to Lexology today they cover barely 15% of current home values in the Golden State.
Homestead Exemption is Now as High as $600,000
In September 2020, Governor Gavin Newsom signed Assembly Bill 1885 into law, which increases the homestead exemption considerably. Effective January 1, 2021, the new exemption will have a minimum baseline of $300,000, and can be as high as $600,000 based on the median sale price of homes within the county of the property in question. In addition, these amounts will also be adjusted for inflation in the future and will increase automatically without further action by the legislature. That will help avoid the exemption amount becoming out-of-date as it has in the past.
How the Homestead Exemption Provides Asset Protection
As an estate planning attorney, the subject of asset protection is often part of the conversation that we have with our clients. I'm happy to say that the new law provides a degree of asset protection for the family home that did not practically exist with the former law due to the low exemption amounts. What follows will briefly describe how a creditor can go after a debtor's real estate, and explains how the homestead exemption protects the equity in the home from such claims and can even prevent a forced sale altogether.
When a creditor obtains a judgment in a lawsuit, they are able to record that judgment (referred to as an Abstract of Judgment) in the County in which the debtor owns real estate. This then allows the creditor to file what is known as a Writ of Sale, which directs the County Sheriff to force the sale of the property at a public auction and distribute the proceeds to the creditor.
The homestead exemption protects a person's primary residence from forced sale by a creditor if the sale will not produce sufficient proceeds to satisfy liens against the property (such as a mortgage) and still leave the debtor with the amount of the homestead exemption. In other words, if the net proceeds from the sale of the home would be less than the exemption amount (which is now up to $600,000), a creditor cannot force a sale of the home. Furthermore, if there is equity in the home in excess of the exemption, and a sale is forced by a creditor, the homestead exemption also ensures that the homeowner receives the amount of the exemption before the creditors are paid anything from the sale proceeds.
Automatic Statutory Homestead vs Declared Homestead
There are two types of homestead exemptions available: an Automatic Statutory Homestead, and a Declared Homestead. The amount of the exemption is the same for both types. The difference is that taking the extra step of recording a Homestead Declaration provides some additional protection, most notably in that, in addition to protecting against a forced sale, it also protects the home equity if the home is voluntarily sold and the proceeds are used to purchase a replacement home within 6 months. It also allows the homeowner who has multiple residences the ability to select which home to apply the exemption to.
Automatic Statutory Homestead: This exemption applies to a person's principal dwelling automatically. No form needs to be recorded. However, the exemption only applies in the context of a forced sale.
Declared Homestead Exemption: You can convert the Automatic Statutory Homestead to a Declared Homestead by recording a Homestead Declaration form with the County. By making your Homestead a Declared Homestead, in addition to applying in the context of a forced sale (like the Automatic Homestead does), a Declared Homestead also protects the exempt amount of equity if the homeowner voluntarily chooses to sell and allocates those funds to a replacement residence within 6 months. Recording the Declaration also allows a homeowner to designate which specific residence they want to apply the Homestead to if debtor owns two or more properties that could be considered their primary residence.
Consider the New Exemption as Part of an Asset Protection Strategy
Before the new law was passed, protecting the personal residence from creditors typically required giving it away to an irrevocable trust, transferring title to an LLC (which actually causes a loss of the homestead exemption and may cause property tax reassessment either immediately or following a death) or taking out large loans on the property and transferring the money to more favorable asset protection jurisdictions either domestically or offshore. While those are all still valid strategies, it is nice to have a simple, low cost-no cost option such as the homestead exemption now providing some meaningful protection under the new law.