John Schaub's Strategies and Solutions -
Internet Reprint
(c) Proserve Corporation of Sarasota, Inc. 2000. All Rights Reserved
# 9511
LAND TRUSTS - A STEP IN SAFEGUARDING YOUR NET WORTH
As your net worth grows, you may spend more time thinking about how not to lose what you have acquired. Becoming overly defensive is not a good strategy. Continuing to build your net worth is a healthier approach than simply trying to hold on to what you have accumulated. It's also a lot more fun to continue to make money, than to just count what you have.
Whether you are buying your first house or your fiftieth, you should take some simple steps to protect the real estate you own from claims of others. The first step is to find a good insurance agent and buy liability insurance. I recommend at least a one million dollar umbrella coverage in addition to your normal required coverage. I suggest using a well established independent agent who has a great deal of experience in real estate. S/He should be able to find a company with competitive rates that can provide the coverage tailored to your needs.
The next step is to lower your profile as a target for a potential lawsuit. In my special report Financial Privacy For Real Estate Investors, I detail how you can own a lot of property and still maintain a low profile. One step in that strategy is the use of land trusts to hold title. In this issue I will explain in detail how to use land trusts.
I am not a lawyer, and if you aren't either I recommend that you follow my example and befriend an attorney. Select one that specializes in real estate; one with experience as a landlord would be a valuable addition to your investment team. It is important that you work with someone whom you trust and respect.. If you see your lawyer as an adversary, you will not get the full benefit of her/his endeavors. Likewise, if he has no experience owning and managing real estate, he may be unaware of some of the nuances (and nuisances) that impact you as a landlord.
The written authority on land trusts is the book Kenoe on Land Trusts, by Henry W. Kenoe, a prominent Illinois lawyer. This tome is still in print and is a great reference book for your attorney. Your local law library should have a copy. Chicago Title Company and Chicago Title and Trust Company are well versed in land trust operations and if they have an office in your area, should be a good resource for setting up a land trust.
I highly recommend that you use a land trust to hold title to your investment properties . Most states allow the use of a land trust, as long as the trustee has some power. Often this requirement is satisfied by giving the trustee the power to liquidate the assets of the trust at a certain date in the future, typically twenty years, and then to distribute the proceeds to the beneficiaries.
Many attorneys are not familiar with a land trust. They are not complicated. Any real estate attorney should be able to understand the basics simply by reading this letter. If they want more information refer them to Kenoe's writing or Chicago Title.
WHAT IS A LAND TRUST AND WHY SHOULD YOU USE ONE
A land trust is a device that separates the ownership in the property (full title is vested in the trustee) from the ownership of the beneficial
interests (which are owned by you, the investor). You can be your own trustee, but typically you want to use a third party. The sole function of the trustee is to hold title, and then sign documents as directed by the beneficiary to transfer title to another, lease, or finance the property. The trustee may also have the power to liquidate the assets of the trust and distribute the proceeds to the beneficiaries at some point in the future.
The beneficiary, who is the owner of the assets of the trust, retains the responsibility for management and control of the property. The beneficiary solicits and selects tenants, collects rents, pays the taxes and insurance and other bills, maintains the property and completely controls the day to day operation of the property.
The beneficiary retains the power of direction to instruct the trustee to buy, sell, exchange, or mortgage the property. When the land trust is created, it is crafted so that the trustee can act only with written instructions from the beneficiary to perform any of these operations.
A land trust allows the person who would otherwise be the owner of record, to have the title held in another's name as trustee. Although there are other benefits, privacy is a key reason for using a land trust. Someone researching the title would then not know who, in reality, owned the beneficial rights (that's where the profit is) to the property. The trustee of a land trust is generally prohibited from revealing the identities of the beneficiaries to the public in the initiating documents.
Land trusts are commonly used in most states and are either defined in those states by a statute (Florida, Virginia,, North Dakota, Indiana, and Hawaii) or by court cases. Land trusts were pioneered by Illinois lawyers and inspired by the Massachusetts Business Trust. You will hear the term "Illinois Land Trust", referring to this system of ownership and management.
A LAND TRUST CREATES PERSONAL PROPERTY - THE BENEFICIAL INTERESTS
The trustee holds title to the real estate. The beneficiaries have no interest in the real estate, but own the beneficial interest in the trust which is personal property. This is significant for a number of reasons:
1. Personal property has different probate requirements than real property
2. A land trust allows the beneficiary to sell or give away portions of his interest without
subdividing the property or deeding a partial interest in the real estate;
3. Personal property transfers are generally not recorded in the public records, the trustee is
simply notified of any transfer of beneficial interest;
4. The beneficiary of a land trust could even be another trust, perhaps a living trust.
If you are sued, a smart attorney may ask you if you own the beneficial interest in any trust. If at that point you did, you would be obliged (under oath) to answer yes. However, a beneficial interest in a land trust is personal property and does not appear on the public records. You can easily and quietly transfer your interest in a land trust to someone else long before the attorney asks his question.
HOW DO YOU CREATE A LAND TRUST?
A land trust is created by two instruments: the deed to the trust and the trust agreement.. Although not part of the creation of the trust, if there is more than one beneficiary then a third document, the beneficiaries agreement, should be created
The first instrument, the deed in to the trust, transfers title to the trustee. This document is recorded in the public records, and transfers title to the trustee. And, the language of this deed which conveys the property into trust is important because it gives the trustee the right to convey to others, to lease, to option, to mortgage, to exchange, to generally do anything that a typical owner could do.
This deed into the land trust can - and should - come directly from the seller of a property being acquired. By having the title transfer directly from the seller to your trustee, your name will not appear on the public records. You can contract to buy a property and assign the contract to your trustee. Most contracts are assignable. If you are not sure, list the buyers on the contract as "Your Name, or assignees", for example "John Schaub or assignees".
The deed to the trustee does not spell out who the beneficiaries are or the agreement between the beneficiaries and the trustee. It does specify the powers of the trustee. Below I've included some typical language from a deed into a land trust so that you can consider how powerful the trustee is. Notice that the trustee is granted authority to do everything, and that the public can rely on the trustee's performance without verifying anything with the (unknown) beneficiaries. Obviously, you need to select the right trustee, and I address that subject later. (This language is excerpted from the Chicago Title and Trust Company's Warranty Deed in Trust . For a sample set of forms used to form a land trust write to Land Trust Department, Chicago Title and Trust Company. 111 West Washington Street, Chicago, IL 60602)
Full power and authority is hereby granted to said trustee to improve, manage, protect and subdivide said premises or any part thereof, ... to contract to sell, to grant options to purchase, to sell on any terms, to convey with or without consideration,, to convey said premises or any part within to a successor in trust and to grant said successor all of the title, estate powers and authorities vested in said trustee, to donate, dedicate, mortgage, pledge or otherwise encumber said property or any part thereof, to lease said property or any part thereof, ....to partition or exchange said property for real or personal property, to grant easements or charges of any kind...
In no case should any party dealing with said trustee in relation to said premises, or to whom said premises or any part be conveyed, contracted to be sold, leased, or mortgaged by said trustee, be obliged to see the application of any purchase money, rent, or money borrowed or advanced on said premises, or be obliged to see to that the terms of this trust have been complied with, or to be obliged to inquire into the necessity or expediency of any act of said trustee, or be obliged or privilege to inquire into any of the terms of said trust agreement, and every deed, trust deed, mortgage, lease or other instrument executed by said trustee in relation to said real estate shall be conclusive evidence in favor of every person relying upon or claiming under any conveyance, lease, or instrument, (a) that at the time of delivery thereof the trust created by this indenture and by said trust agreement was in full force and effect, (b) that said conveyance or other instrument was executed in accordance with the trusts, conditions and limitations contained in this indenture and in said trust agreement and in some amendment thereof and was binding upon all beneficiaries thereunder; (c) that said trustee was duly authorized to execute and deliver every such deed, trust deed, lease, mortgage or other instrument; (d) if a conveyance is made to a successor or successors in trust, that such successor or successors in trust have been properly appointed and are fully vested with all of the title, estate, rights, powers, authorities, duties, and obligations of its, his, or their predecessors in trust.
The second instrument required to form the trust is the trust agreement. The trust agreement limits what the trustee is authorized to do. It spells out the duties of the trustee, the rights of the beneficiaries, and the relationship between the trustee and the beneficiaries. It builds in protection for the trustee against suits. It can provide for the termination of the trust at some point.
When there are multiple beneficiaries, you should have an agreement between the benefactions. This agreement is similar to a partnership agreement and can deal with issues of management responsibilities, buy/sell agreements, and additional contributions of capital. Certainly if the trust owns real estate that may break (such as a house)or sit vacant, some provision should be made if one of the beneficiaries cannot come up with his share of a cash requirement. Likewise, management responsibilities should be detailed. If one of the beneficiaries is responsible for this work, is this person compensated? What happens if one beneficiary wants to direct the trustee to sell, and another beneficiary doesn't agree? Many investors skip this part until problems arise - and then are disappointed with the hassles. .
A land trust can be a good alternative to using a partnership. Discuss the benefits and costs with your accountant next time you consider forming a partnership that involves real property.
DUTIES AND RESPONSIBILITIES AND LIABILITIES OF THE TRUSTEE
The trustee's only duties are detailed in the trust agreement. The trustee has no management responsibilities under this system, (regardless of what the trust deed states) and is indemnified against any actions against him because of his position of trustee by the beneficiaries.
His sole responsibilities are to convey, or mortgage the property or to deal with the real estate as directed by the beneficiaries, or to sell or liquidate the property at the termination of the trust. The trustee has no duty to insure that the beneficiaries are properly managing the property or that the directions that the beneficiaries are giving to the trustee are wise or even legal.
The trustee takes direction from the beneficiaries to sign deeds and any other instruments that may affect title to the property. He acts only upon the specific written request of the beneficiaries. Literally, the trustee just sits back and does nothing without written instructions. In a way, this makes sense: the trustee will not benefit in any way from profits created by the trust.
In the event a beneficiary sells or otherwise transfers his interest, they must notify the trustee in writing, and until they do the transfer is not binding upon the trustee. Therefore, if you ever purchase the beneficial interest in a land trust, be sure the trustee is notified promptly in writing.
WHO SHOULD BE YOUR TRUSTEE?
An institutional trustee such as Chicago Title and Trust Company will naturally charge a fee for holding title, and subsequently signing documents required during the life of the trust. Because the beneficiaries take full responsibility for management, the work of the trustee is extremely limited. Therefore, the charges should be less than for a situation where the trustee takes an active management role. This fee is nominal in comparison to the benefits, and using an institutional trustee has some benefits over using an individual:
1. They have unlimited life;
2. They should have professionally prepared forms, well documented by their legal staff;
3. They are available during regular hours to conduct business;
4. They are unlikely to be a party to fraud, and should be insured if fraud occurred.
Using an individual trustee may give you more flexibility, but also increases your risk
1. They may be free (that is, many won't charge you for this minimal work);
2. They may be available to conduct business after hours;
3. They can offer even greater privacy, because no one other than your friend sees the trust
documents.
A non-institutional trustee should be a person with good sense and good character. I also look for someone who has assets of his/her own, hoping that someone who has more money will be less likely to covet my assets. Someone with some business experience and understanding of the term "confidential" is also a plus. Provisions can be made for a successor trustee, but now you need two friends. Even great friends can drift apart. Most importantly, you never want to have to choose between losing a good friend or losing your money.
Another alternative may be your attorney. An attorney has the advantages of being an individual, plus some of the advantages of the trust company. This person should be well prepared to protect your privacy, and may be available for a nominal amount if they are also handling your real estate transactions. Title companies also act as trustees in some areas, and would be comparable to trust companies in their fees and services.
The trustee is typically protected by law against lawsuits and other actions against the property, and the trust agreement will have the beneficiaries agree to reimburse the trustee for any expenses that he may incur. The right of the trustee to resign and provisions for a successor trustee in the event of the incapacitation of the trustee should also be provided for in the trust agreement. Typically, the trustee has the right to resign with a reasonable notice, often twenty days. The beneficiaries can then name a successor trustee and the resigning trustee would then deed the property to the new trustee.
MANAGEMENT OF THE PROPERTY HELD IN TRUST
Although the beneficiary of the land trust is responsible for management, the day-to-day management can be delegated by the beneficiary to another manager. For example, if you owned the beneficial interest in a trust that owned an apartment building, but wanted no contact with tenants, you could hire a management company to handle the daily details.
If you wanted to retain the control over the management, but did not want to be personally associated with the management, the manager could be a corporation you own or control. You may act for the corporation, but receive some liability protection from the corporation.
If you wanted to distance yourself even further from the tenants, consider setting up someone else in the management business. Many owners have helped their managers start a business by training them (or sending them to a well known seminar), guiding them through the incorporation details, then loaning them money for start up capital. The owner then has someone s/he knows well in the business and can contract with this new entity for management.
Although the property owner owns no interest in the management corporation, he would have some influence if he has loaned it money and provides a good deal of it's income through it's management contracts. He could certainly dictate the parameters for the type of tenants, the term of leases, and even designate the rental contracts or leases to be used.
HOW MANY TRUSTS SHOULD YOU USE
One land trust can own an unlimited number of properties, The advantage of using one trust is simplicity, and economy. If you have common beneficiaries for several properties, one trust is my recommendation. For example, if you are acquiring one house a year in your investment program, these houses could be held in one trust. When you have different beneficiaries for different properties, or when you want to transfer the interest in one property by transferring the beneficial interest in the trust rather than transferring title, then a separate trust for that property is recommended.
The paperwork for establishing these trusts is simple and standardized. Setting up a separate trust for each property is not difficult. The trusts are generally numbered rather than named and often the street number of the house is used to help identify the property.
BORROWING MONEY AGAINST ASSETS IN A LAND TRUST
The procedure for borrowing money against assets in a land trust varies from state to state. In Illinois, and other states where land trusts are common, lenders will lend against the beneficial interest in the trust. This leaves the trustee out of the transaction. In states like Florida, where the land trust is accepted, but apparently not understood by lenders, lenders often require the beneficiaries to take title to the property, mortgage it, and then redeed it to the trustee.
This two step exposes to the world the identity of the beneficiaries. I suggest borrowing from the seller of the property as part of the original transaction to acquire leverage at a great interest rate. If you need to borrow against the property after the trustee takes title, consider borrowing from an equity lender. These lenders look only to the property to recover their loan and will accept the mortgage from the trustee without a personal guarantee.
TAX TREATMENT OF TRUST INCOME
The income and expenses generated by property owned in the trust flow through to the beneficiaries proportionate to their interest. Some trusts are required to file a tax return, but not a land trust. There is no tax on the trust income other than what the beneficiary will pay as he reports the income and expenses on his schedule "E".
A property held in a land trust can be exchanged tax free for another property under Section 1031. The trustee would execute a deed out and be the receiver of a deed in for the exchanged property. The beneficiary would report the exchange as if he completed it personally. (For more detail refer to Taking The Mystery Out Of Tax Free Exchanging, available through our office. Call 800-237-9222 9-5, M-F EDT)
Note: The information offered in this letter is part of an ongoing series. This issue builds on the information given in previous issues. The author and publisher are not engaged in offering tax or legal advice. Laws are constantly changing and advice of a competent accountant and attorney should be obtained before implementing strategies suggested in this letter.
Strategies and Solutions is published six times annually. Annual Subscription $47.00. To subscribe or for information on John Schaub Seminar and tape courses call Dottie at 800-237-9222 Please have your Visa/ MC or Discover Card handy
Fax 24 hours 941-957-3646
