Have you been told land trusts are not valid in your state? If not then it is only a matter of time until you run into a professional who will make this representation. Not surprisingly, ninety percent of the time it is a local attorney making the statement. Why the erroneous advice? Because the attorney is not familiar with the basic principles of trust law. Most attorneys operate in a legal world where statutes control their view of the law i.e., if you are not familiar with a particular body of law and you cannot find a statute to support your idea, then the safest assumption when dealing with a client is to tell them it will not work. In other words, if an attorney is not up on it then it is safer to be down on it, unless the client is willing to pay to have him thoroughly research the law. Attorneys are adverse to venturing into uncharted waters for fear of liability.
The following states have adopted some form of land trust statute: Florida, Georgia, Hawaii, Illinois, Indiana, Montana, North Dakota, South Dakota, and Virginia. Every other state recognizes the use of trusts via case law, i.e., the common law but with some limitations typically referred to as “Statute of Uses”. This common law doctrine will defeat most attempts to create a land trust unless careful consideration is given to certain principles when drafting your trust document. Three common errors are as follows:
- Dry Trust is Created – If a land trust is not properly funded with real estate the trust will not hold any assets. Thus, the trust becomes null and void and will not be recognized.
- Limited Trustee Duties Create a Passive Trust – A trustee must be given active duties to perform with respect to the trust assets otherwise the trust will fail. States such as Illinois, have adopted land trust statutes with the specific purpose to nullify the “Statute of Uses”. In these states, a trustee can be appointed for title holding purposes only without any power over the trust assets. All powers are reserved to the beneficiaries. (This is why most attorneys get it wrong when discussing the use of land trusts. They incorrectly assume this is the type of trust you are creating.)
- Similarity of Parties Result in Application of the Merger Doctrine – A trust will automatically terminate when the same person serves or becomes both the sole trustee and the sole beneficiary of a trust. The trust is ignored and the law views the beneficiary as the owner of the property regardless of how title is held.
These problems can be avoided with proper drafting of your land trust:
- Create an Active Trust – Give the trustee of your land trust some duties over the assets of the trust. An Illinois style trust wherein the trustee has no or limited powers should only be used in Illinois. The trustee of your land trust should have the power to collect rents, contract for repairs, pay taxes, and pay for expenses.
- Use More Than One Individual – A single investor should never create a land trust wherein he holds both the beneficiary and trustee position. A single investor should always appoint a third party to serve as the initial trustee. After the trust is funded and the beneficial interest is assigned to a limited liability company, the third party trustee should resign. Upon resignation the investor will become the trustee. If a married couple is creating a land trust, one spouse will serve as the trustee and both can be beneficiaries.
- Properly Fund the Trust – Shortly after a land trust is created and before an assignment of beneficial interest to an entity, the investor should deed the investment property into the name of the trust. When preparing the deed it is imperative to deed the property to the trustee of the trust and not the trust itself.
The land trust has many uses in real estate investing and I will cover these in my next blog post. When dealing with professionals not accustomed to working with real estate investors and the various tools at their disposal, it is not uncommon to run into resistance born out of ignorance. If an attorney dismisses your use of a land trust as not being valid in your state, you can now ask him under what common law principal did he reach his conclusion. Not only will you undoubtedly shock him with your understanding of the law, you might event get him to waive his fee because you will be the one advising him and not the other way around. (Wishful thinking. I haven’t met an attorney yet who won’t try and bill you just for being in his presence.)
UPDATE: Don’t Miss my upcoming Real Estate Investors Asset Protection and Tax Planning Workshop on July 21st and 22nd in Anaheim, California. This workshop very specific topics on the use of entities when investing in real estate. Click below to find out more!