There has been much published in regard to land trusts. However, many real estate investors are completely oblivious to the fact that the land trust, in and of itself, provides absolutely no asset protection. Don’t get me wrong, land trusts are great vehicles for privacy, but privacy will only take you so far. You must use a land trust in conjunction with an entity such as an LLC in order to gain the benefits of asset protection.
The Land Trust Structure
There have been some very good articles written on the mechanics of land trusts to serve as an excellent resource on how land trusts are structured, such as those found on BiggerPockets.com. In a nutshell, a land trust is a grantor trust. A grantor trust is a contract between three parties: the Grantor (creator of the trust), the Trustee (holds legal title to the property through the trust and typically controls the trust assets), and the Beneficiary (holds the use and enjoyment of the assets within the trust). The most common form of grantor trusts in our country is revocable living trusts. The great thing about grantor trusts is that separate tax filings are not required since the profits, depreciation, and expenses associated with the asset will report on your personal 1040 return. Often investors are told they cannot form a land trust in a given state because there are no land trust statutes in said state. This information is not wholly correct. Even though only a handful of states have formal land trust statues, every state has statutes regarding grantor trusts and thus the land trust would be recognized as viable entity in that state since it is a grantor trust.
One of the benefits that a land trust offers is anonymity for the investor. When a property is purchased and the investor desires anonymity, the property should be deeded directly into the land trust. The title will vest to the trustee of the trust. In order to achieve anonymity, a third party must be designated as the trustee in the trust documents. Therefore, when the deed is recorded with the county, the third party trustee will be listed on title instead of the investor. As a practical matter, the investor should be designated as the successor trustee and have a resignation ready to be signed from the third party trustee. If any action needs to occur regarding the property, whether it be a refinance or an unlawful detainer action, the only party that can act on behalf of the trust is the trustee. An investor needs to be able to act immediately on behalf of the trust property if the third party trustee is unavailable to sign the necessary documents.
Anonymity is an extremely useful tool when you are looking to shelter your assets from prying eyes. In a typical lawsuit scenario, before the attorney takes a potential case the he or she will perform an asset search on the party they are looking to sue. The more assets a person has in his or her name the more attractive he or she becomes. The practice of law is a business and the attorney wants to be sure that there are enough assets to recover and attach to the case before undertaking several years of costly litigation. Having a third party serve as the trustee can decrease the investor’s overall target exposure. However, anonymity alone does not guarantee that you will not be sued. We can never protect the property from injury associated with the property. As long as the investor holds the beneficial interest, not only is the property at risk but so are the investor’s other assets.
Lack of Asset Protection
Even though the investor may not be the trustee of the trust he or she is the trust beneficiary. There are pros and cons to being designated as the beneficiary. The beneficiary of the trust not only receives the benefits associated with property in the trust, but all liabilities associated with the property flow down to the beneficiary as well. If the investor personally holds the beneficial interest and there is an injury on the trust property, the plaintiff will seek recovery against the property and the investor individually. If the investor holds beneficial interests in multiple trusts, all of the properties within those land trusts will be at risk even though they had no connection to the underlying harm.
Not only does the investor subject his or herself to personal liability exposure for claims arising from the trust property, his or her trust property is at risk for claims arising against the investor individually. Because the investor individually holds the beneficial interest, his or her interest can be attached by a judgment creditor. Once the judgment creditor attaches the beneficial interest, most trusts give the power to the beneficiary to terminate the trust. In this scenario the judgment creditor would exercise his or her beneficial right by terminating the trust and taking possession over the asset. In order to achieve asset protection, the investor must transfer his or her beneficial interest prior to the harm occurring.
Achieving Asset Protection
In order for asset protection to exist, we must use a land trust in conjunction with an entity that provides asset protection. In most instances, using an LLC is the appropriate entity to achieve asset protection for the investor’s long term holds. The LLC acts as a container for liability exposure, thereby insulating the individual investor, who is the member of the LLC, from harm occurring inside of the LLC. The mechanics of achieving asset protection with the land trust are fairly simple. After the deed has been filed and title has vested in the trustee, the beneficiary has the right (in most instances) to transfer his or her beneficial interest in the trust. This is where the LLC comes into play. The investor will complete an assignment form and transfer his or her interest directly to the LLC. It is also important to have the LLC, or any other entity, accept the assignment of interest. At this point LLC is the owner of the beneficial interest.
If a harm associated with the property arises, unless we are dealing with fraud or gross negligence, the liability exposure will be contained within the LLC. This containment of exposure will help shield the investor from personal liability from the harm relating to the underlying property. In many states, asset protection will also be achieved if the individual investor is subject to a personal suit, since many courts will respect the separate nature of the LLC and not allow a judgment creditor to pierce the LLC and attach assets for an unrelated harm.
Capitalizing on the Full Benefits of Land Trusts
Land trusts are an excellent tool in the investor’s arsenal, but the investor must be savvy enough to fully utilize the trust’s benefits. Not only will the trust provide the investor the desired level of anonymity, but if used in conjunction with an LLC, it will afford the investor excellent asset protection. If anonymity is the only concern then the land trust can achieve this result. However, for the investors that also desire protection, the land trust must be used in conjunction with entities that provide asset protection.