DAVID J. WILLIS ATTORNEY
Copyright © 2013. All rights reserved worldwide.
LAND TRUSTS IN TEXAS
With Comments on Anonymity and Asset Protection
by David J. Willis, J.D., LL.M.
There are many kinds of trusts and most of them can be adapted to hold real estate, either the homestead or investment property. The difference between types of trusts revolves around the intended purpose. One needs to be clear about what one is trying to accomplish before setting out to draft a land trust. This article focuses on two groups of land trusts: transactional trusts (our term) used as short-term devices to acquire or transfer property, and holding trusts (our term again) the purpose of which is to acquire property (either anonymously or otherwise) and hold an asset for a longer term.
The scope of this article is limited to trusts which are formed during the lifetimes of the participants for the purpose of holding investment real estate or other assets. Testamentary trusts, which take effect upon death, are part of the estate planning process and can be substantially different, often because of tax issues. Living trusts for the homestead are addressed in the next chapter.
Types of Land Trusts
Entry trusts are used by an investor to acquire a property to be flipped using an assignment of beneficial interest.
Exit trusts are used by an investor to "sell" property to a buyer who is working to restore credit and obtain financing.
Anonymity trusts are used to hold an asset under the trust´s name with no reference to underlying ownership.
Anonymity Trust/LLC formation is accomplished when a properly drafted anonymity trust is named in the Certificate of Formation of as initial manager of an LLC.
Living trusts for the homestead are used as a probate-avoidance device.
Clients often ask attorneys for a "standard" trust (or worse, a fill-in-the-blank form) neither of which exists at any acceptable level of quality. There is no substitute for the analysis and drafting expertise of a competent professional in this complex area. The challenge for the attorney is to discover what the client is trying to achieve and then tailor a document to suit specific needs.
While land trusts can be used flexibly, and there are a number of ways to write these trusts, there are certain structural items that do not change:
(1) The trustor (or grantor) is the current title-holder to the property. The trustor is therefore the person/entity who transfers property into the trust.
(2) The trust corpus (or trust estate) is the real property or other asset that is conveyed into the trust.
(3) The trustee (which cannot be an LLC) is the manager/administrator of the trust with authority to manage, maintain, lease, and sell the trust property.
(4) The successor trustee serves if the trustee dies, resigns, or cannot otherwise serve.
(5) The beneficiary is the true party in interest, the one with "ownership" to use that term loosely.
(6) The contingent beneficiary takes the beneficial interest if the original beneficiary dies (note that there would be no contingent beneficiary if the beneficiary originally named is an LLC).
The same person cannot serve as trustor, trustee, and beneficiary or the trust disappears as a matter of law (the doctrine of merger). In order for an attorney to draft a land trust, the client needs to specify which persons or entities will be acting in each role.
There are two parts to the land trust process: (1) creating the trust, and (2) conveying the property or asset into the trust by means of a warranty deed (realty) and/or bill of sale (non-realty).
The Entry Trust (Investor Acquisition of Property in Preparation for a Flip)
There are two types of transactional land trusts available to real estate investors: (1) an entry trust used as a tool to acquire and then transfer real estate by means of an assignment of beneficial interest, and (2) an exit trust designed to hold title to real estate while an under-qualified buyer does credit repair until able to obtain a third-party loan to take the property out of trust. Both are popular.
In the case of entry trust, an investor coaxes a distressed seller into transferring property by recorded deed into a trust, after which the seller then executes an unrecorded assignment of beneficial interest to the investor. This is usually done in anticipation of a foreclosure. Entry trusts have the benefit of a certain measure of anonymity. However, these trusts do not delay or stop foreclosure unless the investor is willing to reinstate the loan and continue to make payments until the property is sold.
Drafting the entry trust is critical. Certain types of trusts allow the original seller to retain a beneficial interest (always a bad idea) that allows the original seller to a share of the profits when the property is flipped. Others permit the original seller to have a power of direction over the trustee-an even worse idea.
A significant risk, from the investor´s point of view, is that the original seller may still transfer the property to someone else in defiance of the unrecorded assignment of beneficial interest that has been given to the investor. For this reason, depending on the circumstances, a "subject to" deed may be a simpler and better solution than an entry trust. For asset protection purposes, the grantee on the subject to deed should be the investor´s LLC.
The Exit Trust (Transfer to a Trust Pending Credit Repair by a Buyer)
Exit trusts can be a bit complicated. Basically, the trustor (the investor) is the "seller." A credit-impaired "buyer" is designated as a majority beneficiary of the trust.
The property is conveyed into trust and the buyer takes immediate possession. The trust acts as a temporary parking place for the property while the buyer works to obtain conventional financing in order to purchase the property outright at a specified price. Sound similar to a lease option? It is, except that beneficial interests in a trust are personal property, not real property, and therefore one can plausibly assert that they do not fall under executory contract provisions of the Property Code.
Structurally, an exit trust might work like this: the trust names a minority (10%) beneficiary, who is the trustor/investor/seller; and a majority (90%) beneficiary (buyer) who acquires an option to purchase the minority beneficiary´s 10% interest at a fixed option price. The option is exercisable within a specified term so long as the majority beneficiary/buyer is not in default.
There is no deed, recorded or unrecorded, into the name of the buyer, since he or she is not acquiring title to the property at the time the trust is created. That action is deferred until credit repair and third-party financing are complete. For the time being, the only warranty deed being executed is the deed into the trust.
Creation of an exit trust is a private transaction except for the recording of a warranty deed into the trust. In order to achieve maximum anonymity, the name of the trust should be generic and not include names of any parties to the trust.
Use of an LLC in Combination with an Exit Trust
Trust law in Texas falls under the Property Code, whereas the law of business entities (such as LLCs and corporations) falls under the Business Organizations Code. This gives us a clue as to the respective function of such entities. Trusts can hold property, but there is no liability barrier against lawsuits as is the case with entities that are formed under the Business Organizations Code. The property might be anonymously held, but the trust-and the participants in the trust-are still individually exposed.
How may an exit trust be combined with an LLC? The trustor/investor first conveys the property into an LLC, which is followed by a transfer from the LLC into the trust. Including the LLC into this structure adds significant asset protection since, as stated, a trust alone has no liability barrier.
Trusts combined with LLCs can present significant hurdles to a plaintiff who wishes to find and sue the property owner. A series LLC, which allows assets and liabilities to be held in insulated compartments, is recommended.
Caution: Exit Trusts are a Form of Seller Financing
Seller financing, always popular in Texas, is a way to sell real estate in an economy where conventional financing is scarce. Unfortunately, Texas Property Code changes made in 2005 (Sec. 5.061et seq.), the S.A.F.E. Act, and the Dodd/Frank law have combined to make seller financing of residential real estate a challenge. The new seven-day notice requirement contained in Property Code Sec. 5.016 also applies. See our companion article entitled Owner Financing in Texas.
We mention the subject of seller financing because clients occasionally ask if the use of a trust (an "exit trust" for example) constitutes seller financing. While we are not aware of any court cases on this subject, the answer is likely yes.
Exit Trusts Are a Form of Seller Financing
The executory contract rules of Property Code sections 5.061 et seq., the SAFE Act, and the Dodd/Frank law have combined to make seller financing of residential real estate a challenge. The subject of seller financing is mentioned here because clients occasionally ask if use of a trust (an exit trust for example) constitutes seller financing. The answer is yes.
The Exit Trust as an Alternative to Lease Options
A well-drafted land trust provides an alternative to lease-option transactions, which are now defined to be executory contracts. And generally speaking, executory contracts in residential transactions are unworkably difficult, just as the legislature intended. However, one can argue with a straight face that a land trust falls outside the executory contract rules so long as the trust agreement provides for an option to purchase a beneficial interest in the trust (which is personal property), not an option to purchase the real property itself.
The Anonymity Trust
The anonymity trust is a trust agreement that is executed along with a warranty deed conveying real property into the trust. The traditional way for a trust to hold property is by expressly stating the name of the trustee, e.g., "John Jones, Trustee;" however, it is just as feasible to hold title in the name of the trust-e.g., the "123 Oak Street Trust." It is untrue that one must name the trustee in the deed for purposes of recording, since county clerks gladly record such deeds so long as they are property executed and acknowledged. Anyone seeking to know who the principals are and what assets they may have has their work cut out for them.
Title companies, however, usually object to this approach based on the fact that a trust is not an actual legal entity (and least not in the same sense that a person or an LLC is) and therefore cannot hold property if the trustee (who is a legal person) is not specifically named in the deed. Users of anonymity trusts should anticipate future objections from a title company, since title company attorneys love to be self-righteous on this issue. An investor should therefore be prepared to re-execute and re-record a deed which names the trustee. This is a minor inconvenience, and since anonymity has been preserved during the time of ownership, the strategy has been a success.
A written trust agreement must actually exist for this strategy to work. There are two good reasons for this: a title company usually wants to see a copy of the trust agreement before transferring title out of the trust to a new buyer; and secondly, courts are likely to ignore the existence of an alleged trust that has no written trust agreement behind it.
Anonymity Trusts Used in LLC Formation
It is required in formation documents that the organizer of an LLC indicate who will be initial manager of the company. This firm has devised a creative but effective way to name an anonymity trust as initial manager while using an attorney as organizer and registered agent, all in order to achieve anonymity for the client. This requires sophisticated documentation to complete, particularly when done in conjunction with a series LLC.
The Title Company and the Trust Agreement
When trust property is sold, it is likely that the title company will want to see the trust agreement. A written trust agreement must therefore exist. It is important that the trust be properly drafted so that the title company will accept it as valid. Otherwise, the title company may ignore the trust altogether and require signatures from all persons having an actual or potential interest in the property or, in the alternative, a judicial determination of heirship-either of which defeats the purpose of creating the trust in the first place.
It is widely advertised by seminar gurus that land trusts prevent a lender from exercising due-on-sale. However, Garn-St. Germain (the federal living trust exception) was intended to create an exception for transfers of property to family living trusts designed to avoid probate. It was not intended to provide a safe haven for investors seeking to use trusts as part of their business plan. The truth is that a land trust does not defeat due-on-sale because a land trust invariably contemplates a transfer of rights of occupancy-so due-on-sale provisions remain effective and enforceable. Nonetheless, so long as monthly payments remain current, the discussion may be academic since lenders are generally loathe to foreclose on performing loans.
Not all land trusts are created equal. There are a myriad of trusts available on the Internet that purport to be good in all fifty states. This is a false. A principal defect of trusts marketed over the Internet is failure to consider or comply with Property Code section 5.061 pertaining to executory contracts. Some attempt to create liens that are unenforceable in Texas. Many involve complex, exotically-named transactional documentation with "fill-in-the-blank" forms, a sure indicator that they are junk. The place to get a valid Texas land trust is from an experienced Texas asset protection lawyer who knows what he or she is doing in this area..
Information in this article is proved for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. No attorney-client relationship is created by the offering of this article. This firm does not represent you unless and until it is expressly retained in writing to do so. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well, since we do not give tax advice.
Copyright © 2013 by David J. Willis. All rights reserved. Mr. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, http://www.LoneStarLandLaw.com.
8000-FDIC Miscellaneous Statutes and Regulations
PART591CPREEMPTION OF STATE DUE-ON-SALE LAWS
' 591.5 Limitation on exercise of due-on-sale clauses.
(a) General. Except as provided in '' 591.4(c) and (d)(4) of this part, due-on-sale practices of Federal savings associations and other lenders shall be governed exclusively by the Office's regulations, in preemption of and without regard to any limitations imposed by state law on either their inclusion or exercise including, without limitation, state law prohibitions against restraints on alienation, prohibitions against penalties and forfeitures, equitable restrictions and state law dealing with equitable transfers.
(b) Specific limitations. With respect to any loan on the security of a home occupied or to be occupied by the borrower,
(1) A lender shall not (except with regard to a reverse mortgage) exercise its option pursuant to a due-on-sale clause upon:
(i) The creation of a lien or other encumbrance subordinate to the lender´s securit instrument which does not relate to a transfer of rights of occupancy in the property: Provided, That such lien or encumbrance is not created pursuant to a contract for deed;
(ii) The creation of a purchase-money security interest for household appliances;
(iii) A transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety;
(iv) The granting of a leasehold interest which has a term of three years or less and which does not contain an option to purchase (that is, either a lease of more than three years or a lease with an option to purchase will allow the exercise of a due-on-sale clause);
(v) A transfer, in which the transferee is a person who occupies or will occupy the property, which is:
(A) A transfer to a relative resulting from the death of the borrower;
(B) A transfer where the spouse or child(ren) becomes an owner of the property; or
(C) A transfer resulting from a decree of dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement by which the spouse becomes an owner of the property; or
(vi) A transfer into an inter vivos trust in which the borrower is and remains the beneficiary and occupant of the property, unless, as a condition precedent to such transfer, the borrower refuses to provide the lender with reasonable means acceptable to the lender by which the lender will be assured of timely notice of any subsequent transfer of the beneficial interest or change in occupancy.