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Land Trusts: The Most Effective Way to Hide and Protect Your Real Estate AssetsBy Ramon M. Gonzalez, Esq. (©All Rights Reserved 2008)
“Own nothing and control everything.” John D. Rockefeller’s most famous quote captures the essence of asset protection. Mr. Rockefeller almost certainly used land trusts, a legal device which allows you to retain all the benefits of property ownership without exposure to public scrutiny and litigation. A land trust is a type of living revocable trust which allows an individual or entity to hold title to real property as a beneficiary through a trustee. The trustee is a nominee titleholder while the beneficiary retains control and management of the property, including the right to receive all profits and income. The trustee executes deeds, mortgages, contracts and otherwise deals with the property only at the written direction of the beneficiary. Any real property can be held in a land trust, including a subdivision, development, condominium building or unit, commercial property, apartment complex, raw land and even a long-term commercial lease.
A land trust is created by the execution of two documents: a land trust agreement (“LTA”), which sets forth the rights and duties of the trustee and beneficiary, and a deed to trustee (“DTT”), which transfers the property into the trust. Only the DTT is publicly recorded; therefore, the true owner/beneficiary's name never appears in public records. This protects the anonymity of the beneficiary and significantly limits potential exposure to lawsuits. If predators and creditors cannot find your assets, they will likely move on to more promising targets.
Note that holding title in your own name not only makes you easy to find and sue but also exposes you to personal liability. More importantly, if you are found liable for a tort or breach of contract, or if you owe a debt or taxes, all your properties can be attached and levied to satisfy the judgment or lien. This is true even if the lawsuit or debt has nothing to do with the subject property. You will be unable to sell or refinance the property until you pay off all liens against it. In California, these liens attach for ten years and can be reattached every decade thereafter.
However, if you hold property in a land trust, any judgment that attaches to you personally will not attach to the trust property or to your properties held in other land trusts. Conversely, if a judgment attaches to the trust property, it will not attach to you personally or to any of your other properties. In fact, if the beneficiary of your land trust is an LLC, you will not be personally liable in the event of a lawsuit even if your own negligence resulted in the injury.
II. HISTORY AND LEGALITY OF LAND TRUSTS
Land trusts first became popular about 500 years ago in feudal England when land was the primary form of wealth and could be seized by the king for any number of transgressions. To hide and protect their clients’ properties from the monarchy, lawyers created land trusts. During the mid-1800s, railroad companies in the United States used land trusts to hide their identities when buying large tracts of land to avoided paying more than necessary. Today, major developers like Donald Trump continue to use land trusts for this very reason. Land trusts became a part of American common law through legislative statutes and judicial decisions. Many states enacted statutes expressly recognizing land trusts (including Alabama, Florida, Georgia, Hawaii, Illinois, Indiana, North Dakota, Ohio and Virginia), while others enacted statutes impliedly authorizing them. Other states, such as California, expressly recognize land trusts through case law or general common law trust principles.
III. LAND TRUST BASICS
A land trust is simply a contract that allows a trusted individual (the “trustee”) to hold title for the benefit of another (the “beneficiary”). The trustee owes a legal or “fiduciary” duty to the beneficiary to ensure that the beneficiary’s financial interests are protected. As a matter of law, a land trust is considered to be a living revocable trust because it is created and exists while the beneficiary is alive and can be changed or revoked at any time.
The LTA establishes the land trust, which is funded when the property is transferred therein by the DTT. If you or your business entity already owns the subject property, you deed the property into the land trust via a quit claim deed. If you are about to buy the property, you take title in the name of the trust by having your trustee execute the warranty deed in his or her own name as trustee. The beneficiary’s name never appears on the deed. Because the LTA is never recorded, only the beneficiary and the trustee know of the true owner’s identity. As a matter of law, the trustee can never disclose the identity of the beneficiary without a court order.
The assets of the land trust are known as the “corpus” or the “res.” Because the land trust is a living revocable trust, the beneficiary’s interest is considered to be personal and not real property. This is critical because any judgment against the beneficiary will never attach only to the trust property. However, if a plaintiff’s lawyer or judgment creditor (including the IRS) somehow learns that you have a beneficial interest in the trust, the creditor can try to attach your personal property interest in the trust (i.e., your share of the trust property if there are multiple beneficiaries). However, this will likely be a long, complicated and expensive process and will dissuade most plaintiffs’ attorneys. Indeed, as the beneficiary, you would legally be able to deny under oath in a court of law or at a deposition that you “own” the subject property (or any property if all your other properties are held in land trusts). Only an extremely savvy attorney would know enough to ask if you held a beneficial interest therein.
IV. BENEFITS OF A LAND TRUST
A. Protection of Your Privacy
If you own properties, the biggest nightmare you face is being personally named in a lawsuit. One in ten Americans is sued in their lifetime and one is sued every three seconds. The first line of defense against litigation is keeping your name out of public records. Never hold title to property in your own name! When a plaintiff’s lawyer wants to sue the owner of a property, he runs the property address through a public records database. If your name appears as the owner, he will know whom to personally name as the defendant. He will then run your name through public records to determine if you own other properties. If you do, he knows that every single one of your properties can be attached to satisfy a judgment. In fact, he knows that you might want to settle early just to avoid having liens placed against your properties. He can even calculate how much equity you have in each property because public records usually show the amount of the loan, interest rate and date you started making payments.
Privacy is particularly important when you own rental properties. By holding title through a trustee, you can collect rents and operate as the “manager” without your tenants knowing you are the true owner of the property. By doing so, you can avoid tenants asking you for special favors who will otherwise know you have certain flexibility. Similarly, if a code enforcement official finds a violation in one of your buildings, he or she may very well investigate your other properties to look for similar violations. This will be difficult to do if none of your properties are held in your own (or even your LLC’s) name.
Most savvy real estate investors who aren’t familiar with land trusts take title to real estate in an LLC, LP or S-Corp to limit potential personal liability. However, it takes only moments to find out the name of the managing member or officer of the entity through the Secretary of State’s website because such information is a matter of public record. Thus, these entities provide no privacy whatsoever. This means that the managing member or officer will be personally named in a lawsuit related to a particular property. Land trusts do not have to be registered with any Secretary of State or tax authority, including the IRS.
Finally, a land trust will prevent other potential predators from knowing where you live. It takes only a few minutes to search public records to find your personal residence, then surf the Internet for a map link and even satellite images to your house. Thus, land trusts are particularly important for celebrities, high-profile individuals, or anyone who wants to protect their family.
B. Protection Against Litigation
The vast majority of plaintiff’s lawyers work on a contingency basis, which means that they don’t get paid unless they settle the case or collect on a judgment. If lawyers don’t think they’ll be able to collect from a defendant, they will likely wait for a more promising target.
If your property is held in a land trust, the plaintiff’s lawyer will have no choice but to name the trustee as the defendant. However, the trustee has no personal liability when serving in that capacity so long as he does not commit fraud, exceed his power, and always represents to third parties that he is serving as a trustee and is not the personal owner of the property. Thus, the plaintiff’s lawyer knows the trustee cannot be forced to personally satisfy a judgment. At best, the lawyer will know that the only real property he can attach will be the underlying trust property. The lawyer cannot attach any other assets held in separate land trusts by the beneficiary.
The trustee escapes personal liability because he does not legally control or manage the trust property. The beneficiary, however, retains this power and therefore owes a duty to protect third parties from an unreasonable risk of foreseeable harm relating to the trust property. Therefore, a beneficiary can be found personally liable for negligently mismanaging the trust property if such negligence results in injury or financial loss. If the beneficiary is found personally liable for any tort, regardless of whether the claim relates to the trust property, the trust property can never be attached because the land trust, and not the beneficiary, owns the trust property. Therefore, even if the beneficiary has numerous judgments and liens against him or her, he or she can still freely transfer (i.e., sell) the trust property. Further, the beneficiary can buy other properties through a land trustee without having those personal judgments and liens attach thereto. Note that the beneficiary’s personal property interest in the trust can theoretically be attached to satisfy a judgment or lien. However, the law is unclear as to how this is accomplished. In any event, doing so will certainly prove to be a complicated, time-consuming and expensive process, and subject to appeal. These facts alone should deter most lawyers.
More importantly, even if a lawyer is savvy and persistent enough to identify the beneficiary and go after the beneficiary’s personal interest in the land trust, the lawyer knows that if there are multiple beneficiaries, only the defendant-beneficiary’s share of the land trust can be attached. The other beneficiaries’ shares cannot be attached. More importantly, the lawyer will know that an unscrupulous defendant-beneficiary can simply tear up the LTA, create and backdate a new LTA, and thereby identify a different, non-defendant beneficiary, or, alternatively, simply assign the beneficial interest enough times to create an untraceable daisy chain. The lawyer will know that the threat of a cause of action for fraudulent conveyance and possible punitive damages may not deter the defendant-beneficiary.
Further, if a judgment attaches personally to the beneficiary for a tort that does not involve the property (e.g., an auto accident), neither the trust property nor any of the beneficiary’s other properties can be attached to satisfy the judgment if held in land trusts. This is true even if the IRS comes after the beneficiary with a federal tax lien.
In any event, the beneficiary will not have personal liability if the beneficiary is an LLC. This is true even if negligent mismanagement of the property results in the injury. A separate LLC should be created for each land trust. Never put all your eggs in one basket! This is the critical mistake that even savvy investors make when taking title directly in an LLC – all their properties are held under one LLC. Although the investors escape personal liability by doing so, an attorney can simply attach all the properties owned by the LLC in the event of a judgment.
C. Total Control By the Beneficiary
Under the trust agreement, the trustee has the power to transfer title, execute leases and mortgages, make loans against the property, collect rents and manage the property. However, he can only do if permitted by the LTA or at the written direction of the beneficiary. In other words, virtually every act taken by the trustee that is not explicitly authorized in the LTA or by the beneficiary is illegal. This leaves the beneficiary in absolute control of the trustee and the trust property at all times. If there are multiple beneficiaries, their respective beneficial interests in the corpus of the trust will be set forth in the LTA. Usually only one of the beneficiaries will be the “holder of directive power,” i.e., the sole beneficiary authorized to direct the trustee. By having only one beneficiary serve in this capacity, only his signature is necessary to direct the trustee.
D. Additional Protection If the Trustee is a Knowledgeable Attorney
As a matter of law, a trustee to a land trust can be any entity or individual who is at least 18 years of age and legally capable of entering into a contract. For obvious reasons, do not use family members as trustees who share your last name. Nor do you want a trustee who shares the same residence as you (or who has done so in the past) or who can otherwise be connected to you through public records. Also, be careful about using in-laws. If your marriage goes bad, the trustee may simply attempt to transfer the trust property into your spouse’s name alone!
In any event, your trustee should be reliable, intelligent and knowledgeable about real estate, financial matters and the basics of trust law. Most importantly, the trustee should be utterly trustworthy because he or she can theoretically transfer your property without your knowledge or approval to an unsuspecting buyer. This is why your trustee should be attorney. An attorney is held to a higher standard of care than a non-attorney, particularly when the attorney acts in a fiduciary capacity as a trustee. While attorneys may not necessarily be more trustworthy than non-attorneys, they usually have more to lose (i.e., their law license) if they fraudulently transfer the trust property or engage in any other wrongdoing relating thereto. One phone call to a State Bar’s Ethics Hotline regarding such malfeasance is enough to start an investigation. Also, the attorney-client privilege provides an additional layer of privacy protection.
Further, having an attorney serve as your trustee is useful when you need the legalities of land trusts explained to third parties such as bankers, accountants, real estate professionals, and sellers and buyers of the trust property. Additionally, an attorney carries malpractice insurance which should cover financial losses you incur as a result of poor legal advice regarding your land trust and trust property. Your in-laws won’t be covered by such insurance.
Finally, an attorney presumably will be knowledgeable about land trust law in a particularly state. Indeed, the LTA should have a section specifically setting forth that state’s law regarding land trusts. This should apprise anyone to whom you wish to show the LTA of its legality. For this reason, fill-in-the-blanks LTAs offered by certain real estate gurus are not recommended. In other words, failure to comply with a particular state’s law regarding land trusts could negate the entire trust, which would revert title in the beneficiary’s name.
E. Flexibility in Choosing Beneficiaries and Determining Beneficial Interests
A beneficiary can be an individual, group of individuals, corporation, general partnership, limited partnership, LLC or any combination thereof. If there are multiple beneficiaries, the LTA will identify their respective beneficial interests. The LTA can even specify that the beneficiaries have interests akin to those of tenants-in-common but without the right of partition (see below).
F. Ease of Transferring and Collateralizing Your Beneficial Interest
Unlike a transfer of conventional ownership in real property, which requires closing costs and a mountain of paperwork, a transfer of “personal property” (i.e., the beneficial interest) requires only the execution of an Assignment of Beneficial Interest (“ABI”). (Note that if you transfer your beneficial interest as a result of a sale, you must report the proceeds on your tax returns.) Further, as with the LTA, the ABI is not recorded so the new beneficiary’s confidentiality is protected. Additionally, if there are multiple beneficiaries, only the holder of the power of direction is required to execute directives to the trustee. Finally, because your beneficial interest is considered to be personal property, you can even collateralize it to secure loans so long as you comply with Article 9 of the Uniform Commercial Code.
G. Convenient Ownership, Transfer and Protection with Multiple Beneficiaries
A land trust is ideal for holding title to property through a trustee when there are multiple owners, such as with a general or limited partnership. If a general partnership directly holds title to property, every partner may be required to execute documents relating thereto. However, if the general partnership is the beneficiary to a land trust, only one partner needs to hold the power of direction, and only the trustee is required to execute documents relating thereto. However, because of potential personal liability for general partners, an LLC should be the beneficiary.
In a tenancy-in-common or general partnership, a tenant or partner can file a partition lawsuit to force the liquidation of his or her individual interest in the property. This can obviously be detrimental to the other tenants-in-common or partners because of capital gains taxes and other considerations, such as a below-market sale price. This is strictly forbidden in a LTA because the beneficiaries do not have an ownership interest in the trust property, only a personal property interest in the land trust. Note that a judgment creditor can force a sale of the trust property to satisfy a judgment against one of the multiple beneficiaries, but only to the extent of the debt owed. In other words, the other beneficiaries will retain their respective interests. Further, unlike a general partnership, the acts of one beneficiary will not bind the others. Nor can a beneficiary unilaterally compel the dissolution of the land trust.
Finally, because conveyance of the trust property is made solely by the trustee, a land trust can prevent many of the delays associated with transfers of property held in traditional trusts or others forms of multiple ownership. For example, delays created by the death, incapacity, bankruptcy, litigation, divorce or nonresidency of one of more beneficiaries may be avoided.
H. Avoidance of Probate
If you are concerned about avoiding probate, a testamentary disposition in the LTA will immediately transfer your beneficial interest from your LLC to any individual or entity you choose upon your death. You can even have your beneficial interest transfer to your living trust when you die. By doing so, the terms of your living trust will determine how the beneficial interest is transferred instead of the LTA. This will probably be more efficient if you have multiple properties in separate land trusts so there is only one decisive document (i.e., your living trust) that determines disposition. Alternatively, the LTA can state that the land trust dissolves upon your death, thereby transferring the trust property to your living trust and bypassing probate. The trust property will then become one of the assets of your living trust. By having your living trust be the contingent beneficiary of all your land trusts, each of your trust properties will immediately pass through to your heirs. If there is no testamentary disposition in your land trust, your beneficial interest will become part of your probate estate upon his death. Land trusts also prevent ancillary probate in states where you hold other properties.
I. Absence of Tax Ramifications and Reporting Requirements
The IRS makes no distinction between property owners who hold title in their own names and beneficiaries of land trusts or living revocable trusts for income and estate tax purposes. There are no separate tax reporting requirements for land trusts. The beneficiary continues to report income and expenses as if he or she held title directly in his or her own name. All income and taxes pass directly through the land trust to the beneficiary. The beneficiary continues to deduct mortgage interest and enjoys the same capital gains and homestead exemptions when transferring the trust property (if applicable as a personal residence). There is no transfer tax when transferring property into a land trust. Most states do not even require transfer taxes when you assign your beneficial interest because it is considered to be personalty and not realty. Note that in some states you may have to pay personal property taxes when doing so.
No tax identification number must be filed with the IRS for a land trust. Nor is gift tax due when transferring property into a land trust. The IRS also allows a beneficial interest in a land trust to be exchanged for real property that is not held in a land trust as part of a 1031 exchange or for another beneficial interest in a land trust. Note that if you amend the LTA to allow the trustee to collect rents or directly manage the trust property, you may subject the trustee to certain federal and state tax reporting requirements.
J. Ease of Insuring Trust Property
Because you will no longer be the owner of the trust property, you will no longer be technically covered by the property’s hazard insurance policy. To rectify this, simply notify your property insurance carrier in writing that you have transferred the property into a living revocable trust, and that the new primary insureds will be the trustee in his or her capacity as such, as well as the beneficiaries. (The LTA should contain language that requires the trustee to immediately remit any and all insurance proceeds to the beneficiaries.) If there are any doubts, your insurance agent should be able to rename the insureds once you explain to him or her that you have transferred the property into “a living revocable trust.”
K. Miscellaneous Benefits
There are literally dozens of other benefits to land trusts that are beyond the scope of this article. For example, the author is currently drafting an extensive article about how land trusts allow real estate investors to avoid the dreaded “due on sale” clause in every mortgage contract, provide for safer lease-option agreements, the possibility of entering into no-recourse loans, and voiding lenders’ no-assignment clauses when buying REOs. Other general benefits include keeping property tax assessments lower, keeping sales prices secret, the ease of making gifts relating to the trust property, improving a beneficiary’s asset-debt ratio, saving title insurance premiums, and avoiding tax withholdings on real estate sales for out-of-state residents.
In sum, a land trust is legal in all 50 states and a critical tool for anyone who wants to protect their properties from litigation and/or to ensure privacy. Land trusts are not inexpensive but are a bargain compared with the potentially catastrophic consequences of litigation, levies from judgment creditors and lack of personal safety. Indeed, land trusts will pay for themselves by saving you closing costs, transfer taxes, tax assessments, title insurance premiums, etc. Consider a land trust to be a form of protection as valuable as your hazard insurance policy.
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