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From whom are you receiving your information? This is my typical response to real estate investors who, during the course of a consultation, inform me land trusts are not valid in their state. Not surprisingly, nine times out of ten the answer is a local attorney. Why the erroneous advice? Because the attorney does not understand 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, unless the client is willing to pay to have the attorney thoroughly research the law, he is not going to venture 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 – An investor creates a trust but fails to properly transfer the real estate into the trust. Thus, the trust never holds any assets and will become null and void.
- Limited Trustee Duties Create a Passive Trust – If the land trust does not give the trustee active duties to perform then the trust will fail. States such as Illinois, which have adopted land trust statutes, did so with the explicit intent to nullify the “Statute of Uses”. In these states a trust can be created with a trustee who serves for title holding purposes only and all powers are reserved to the beneficiaries. (Most attorneys unfamiliar with land trusts assume this is the type of trust you will be creating thus, the typical response quoted above.)
- Similarity of Parties Result in Application of the Merger Doctrine – A trust is deemed to have terminated when the same person serves or becomes both the sole trustee and the sole beneficiary of a trust. The law will treat the beneficiary as owning the property outright and the trust is ignored.
These problems can be avoided if you create a land trust with the following features:
- Active Trust – Give the trustee of your trust some meaningful duties other than holding title for the benefit of the trust beneficiaries (typical Illinois style trust). The trustee should have the power to collect rents, perform repairs, pay taxes, and contract for services.
- Multiple Parties – A single individual creating a land trust should always appoint a third party to serve as the initial trustee. After the trust is funded and the beneficial interest is assigned to an entity, the initial trustee can resign and the trust should specify the original beneficiary as the successor trustee. If a married couple is creating a land trust, one spouse can serve as the trustee and both can be beneficiaries.
- Properly Fund the Trust – Within a reasonable period of time after the trust’s creation and before an assignment of beneficial interest to an entity, the investor should deed the property into the name of the trust. When preparing the deed, care should be taken 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 the uninformed attorney who shoots down the idea of a land trust, you can now ask him under what common law principal the trust will not work in your particular state. 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: I have scheduled a Real Estate Investors Asset Protection and Tax Planning Workshop for July 21st and 22nd in Anaheim, California wherein I will be covering land trusts and and so much more. Click below to find out more!