The homestead exemption is important to the many debtors in bankruptcy who own their own homes. But what if the debtor owns the home through his or her single-member LLC? Is that good enough? A Bankruptcy Appellate Panel recently said no, ruling that a debtor whose home was owned by her single-member LLC could not take advantage of the homestead exemption. In re Breece, No. 12-8018, 2013 WL 197399 (B.A.P. 6th Cir. Jan. 18, 2013).

The homestead exemption prevents a debtor’s principal residence from being sold in the debtor’s bankruptcy to satisfy unsecured creditors. The amount of the exemption varies widely by state. If the debtor’s equity in the residence is more than the exemption’s limit, the residence may be sold but the debtor can then retain the exempt amount. In some states, most notoriously Florida, there is no dollar limit on the exemption.

The Facts. Monae Breece and her grandmother jointly purchased a home in Union Town, Ohio in 2004. Several months later they formed an Ohio LLC and transferred ownership of the home to their LLC. Breece’s grandmother subsequently died and Breece became the sole member of the LLC. The residence is subject to a mortgage, and Breece is personally liable for the debt secured by the mortgage. Breece has resided in the home since 2004.

In 2011 Breece filed a voluntary Chapter 7 bankruptcy and claimed a homestead exemption in her residence. The Trustee objected to Breece’s claimed homestead exemption on the basis that the property was owned by the LLC and not by Breece. The bankruptcy court disallowed the homestead exemption, and Breece appealed.

Breece’s claim of homestead exemption was based on Ohio’s exemption statute, which allows an exemption for “the person’s interest, not to exceed [$21,625], in one parcel or item of real or personal property that the person or a dependent of the person uses as a residence.” Ohio Rev. Code § 2329.66(A)(1)(b). The Bankruptcy Appellate Panel therefore had to determine whether Breece had a sufficient interest in her home to satisfy the Ohio statute.

Breece contended that her interest in the residence was sufficient because it was derivative of her interest in the LLC. For example, absent the bankruptcy filing she would be entitled to a distribution of the residence on dissolution of the LLC. Breece, 2013 WL 197399, at *3.

Court’s Analysis. The court began by examining Ohio’s LLC Act. The Act provides that an LLC is a separate legal entity and that a member’s interest in an LLC is personal property. Ohio Rev. Code § 1705.01, § 1705.17. Any real estate owned by an LLC is owned solely by the LLC, and a member has no specific interest in property owned by the LLC. Ohio Rev. Code § 1705.34.

The court then reviewed a decision from the Northern District of Ohio Bankruptcy Court that was closely on point, with very similar facts, In re Stewart, No. 09-7257 (Bankr. N.D. Ohio, Oct. 1, 2010). The arguments and the Stewart court’s conclusions were three-fold. First, the debtors (husband and wife) argued that as sole members of the Delaware LLC, they had an interest in the real estate. But the Stewart court found that under both Ohio and Delaware law, the real estate was owned by the LLC and the members had no ownership interest in the LLC’s property. Stewart, slip op. at 6.

Second, the debtors argued that they had an oral lease in the property, which qualified as an exempt interest under the Ohio statute. The court found, however, that the debtors had only a tenancy at will, which did not qualify as an exempt interest under the statute. Id. at 8.

Third, the debtors raised the alter-ego doctrine and claimed the court should disregard the separate nature of the LLC. The court said that under Ohio law the alter-ego doctrine only applies to third parties and as justice requires, and declined to apply an alter-ego construction. Id. at 11.

The Breece court agreed with the Stewart analysis: “Based on Ohio law, this Panel concludes that the bankruptcy court correctly held that [Breece’s] membership interest in [the LLC] does not bestow on her an interest in the Real Property.” Breece, 2013 WL 197399, at *5.

Breece also argued that Ohio’s homestead exemption should be construed liberally, and that the court should focus on the statute’s reference to the debtor’s use of the property: “real or personal property that the person or a dependent of the person uses as a residence.” Ohio Rev. Code § 2329.66(A)(1)(b) (emphasis added). The court was unconvinced, and found the debtor’s use and possession of the property as a residence to be a necessary but not a sufficient condition for the exemption.

Breece contended that her LLC’s ownership of the residence gave her an equitable interest in the residence. She referenced an Ohio case which had held that equitable title to the debtor’s residence was sufficient to qualify for the homestead exemption. The court pointed out that the equitable title in the earlier case was nothing more than a financing mechanism, which gave the beneficial owner the right to acquire legal title on payment of the debt, and rejected Breece’s equitable-interest argument.

Property of the Estate. The Bankruptcy Code provides that the homestead exemption only applies to property of the estate. Breece, 2013 WL 197399,at *8; see 11 U.S.C. § 522(b). “Property of the estate” is broadly defined at 11 U.S.C. § 541(a), but it does not reach further than the rights the debtor had in property at the commencement of the bankruptcy case. Breece, 2013 WL 197399, at *8.

The court again reviewed Ohio’s LLC Act, emphasized that LLC members do not own the property owned by the LLC and that LLCs are separate and distinct entities, and held that neither the residence nor any interest in the residence is property of the estate. Id. at *9. The homestead exemption therefore could not apply.

In summary, the court held that Breece did not hold an interest in her residence that qualified her for Ohio’s homestead exemption, and that Breece could not claim a homestead exemption because neither the residence nor any interest in it was property of the estate. The court rejected Breece’s homestead exemption claim and affirmed the Bankruptcy Court’s disallowance.

Comment. The court’s conclusions are admirably supported by citations to statutes and case law, but the trees appear to have obscured the court’s view of the forest.

The policies behind the Bankruptcy Code include providing debtors with a clean start and using property exemptions to avoid leaving families destitute and homeless after a bankruptcy. The bankruptcy courts recognize that exemption statutes are generally to be liberally construed in a debtor’s favor, and the Ohio Supreme Court has long recognized that exemption statutes should receive as liberal a construction as can fairly be given to them. Stewart, slip op. at 4-5.

Against that backdrop, consider that there is no other human being with any interest in Breece’s home, whether legal, equitable, direct, indirect, beneficial, or otherwise, other than the owners of the mortgage holder. Consider also that “interest” is neither defined nor limited in the Ohio homestead exemption statute. Breece obviously holds an interest of some sort in the property, whether it be characterized as inchoate or indirect. She controls the LLC and could at any time transfer legal title of the property to herself. Instead of recognizing that reality, the Breece court exalted form over substance and held that Breece had no interest in her home.

Barring further review, though, the Breece result stands. Is there a way for a homeowner to hold his or her residence in a single-member LLC and still preserve the homestead exemption? One possibility would be to execute a written lease from the LLC to the homeowner, with a definite term and some level of rent payment. Because there would be no other members in the LLC, the rent would not have to be at market.

Recall that in Stewart the debtors contended they had an interest in the property because they had an oral lease, but the court found that it was nothing more than a tenancy at will. A written lease with a definite term should normally be construed as creating a real estate interest in the property.