Owners of a Limited Liability Company Cannot Claim Homestead Exemption for Real Property Held by the LLC

In a case before the United States Bankruptcy Court for the District of Connecticut, the Chapter 7 trustee objected to an aggregate homestead exemption claimed by the debtors for property owned by a limited liability company that they controlled at the time of the bankruptcy filing. The court sustained the objection and denied the homestead exemption.

The debtors were joint owners of Kochman Holdings Group, LLC (“the LLC”), which was a single asset real estate holding company established to hold title to a two-story building in West Cornwall, Connecticut. The first floor of the building was used by the debtors to conduct their respective businesses.  A portion of second floor of the building was used as the debtors’ residence, and the remainder of the second floor was used for unspecified personal and business purposes.

In January 2011, the debtors filed for bankruptcy protection under Chapter 7 of the Bankruptcy Code, 11 U.S.C. §§ 701 et seq.  The petition listed their street address as the address of the building owned by the LLC. Pursuant to 11 U.S.C.§ 522(b)(3), the debtors listed personal exemptions allowed by state law, including an aggregate homestead exemption for their primary residence.  See Conn. Gen. Stat. § 52-352b(t) (2009).  The debtors calculated the value of their exemption to be approximately $88,000, which was the total net equity in the building owned by the LLC.  The trustee objected to the homestead exemption.

In Connecticut, any “natural person” is entitled to claim an exemption for his homestead up to $75,000, which is calculated based on the fair market value of the property less the amount of any statutory or consensual lien.  Conn. Gen. Stat. § 52–352b(t) (2009).  A “homestead” is defined as “owner-occupied real property … used as a primary residence.” Id. at § 52–352a (e) (2005)   Case law has further refined this definition to establish three requirements for real property to constitute an individual’s statutory homestead: (1) the individual must “own[ ]” the subject real property within the meaning of Section 52–352a as of the relevant time; (2) the individual must “occup[y] ” the subject real property within the meaning of Section 52–352a as of the relevant time; and (3) the subject real property must be “used as a primary residence” within the meaning of Section 52–352a as of the relevant time. In re Kujan, 286 B.R. 216, 220–21 (Bankr.D.Conn.2002); see also KLC, Inc. v. Trayner, 426 F.3d 172, 175 (2d Cir. 2005) (citing Kujan as “setting out ‘homestead’ requirements for invocation of homestead exemption”).

The exemptions afforded by Section 52-352a only apply to the property of persons, not artificial entities. Shawmut Bank, N.A. v. Valley Farms, et al., 222 Conn. 361, 366 (1992).  When a person elects to own assets through an artificial entity for a legal advantage, such as limiting personal liability, he must accept the corresponding legal disadvantage arising from the limitation of Section 52-352a. Id.

The debtors admitted that the property for which they were claiming a homestead exemption was owned by the LLC.  However, the debtors argued that the equitable doctrine of reverse piercing of the corporate veil should be applied so that they, as sole joint owners of the LLC, could be considered owners of the property for the purposes of claiming the homestead exemption.  The debtors testified that forming an LLC and putting legal title to the property in the name of the LLC were good faith technical transactions that they executed upon the advice of their attorney with no understanding of the implications.

The Bankruptcy Court rejected the debtors’ argument.  In recommending an LLC to hold title to the property, the debtors’ attorney fully understood that the benefits of such an arrangement included preventing the debtors’ individual creditors from reaching the property.  An individual cannot place ownership of a property in an artificial entity so as to be unreachable by his individual creditors, and then later assert ownership of the property so as to be entitled to claim a homestead exemption in it.  The court reinforced precedent by asserting that when an individual choose to take advantage of the benefits of an artificial entity, he must also bear the corresponding burdens.  Because the LLC, and not the debtors, owned the property, the Bankruptcy Court found no basis for the debtors to claim a homestead exemption.

The Bankruptcy Court made the additional finding that, even if the debtors were entitled to claim a homestead exemption, the claim of $88,000 was “patently objectionable” because it represented the entire net equity in the property.  Only the net equity in the portion of the property used as a primary residence could be claimed as a homestead exemption. Because the record contained no evidence as to the value of the residential portion, the Bankruptcy Court would be unable to calculate the value of the homestead exemption, had the exemption been allowed.

Because the Bankruptcy Court found that the debtors did not own the property at the time they filed for bankruptcy protection, they could not claim a homestead exemption in the property.  Therefore, the court sustained the trustee’s objection to the claimed homestead exemption.

Should you have any questions relating to bankruptcy or asset protection issues, please do not hesitate to contact Attorney Susan Maya, at SMaya@Mayalaw.com or 203-221-3100, and Attorney Russell Sweeting, at RSweeting@Mayalaw.com or 203-221-3100, in the Maya Murphy office in Westport, Fairfield County, Connecticut.