DAVID J. WILLIS ATTORNEY
Copyright © 2013. All rights reserved worldwide.
Living Trusts in Texas
by David J. Willis, J.D., LL.M.
This article describes a basic living trust (also called an "inter vivos trust") which is a specific kind of trust designed to hold real property (primarily the homestead) during the life of the trustor in order to avoid probate and (potentially) reduce estate/inheritance taxes at the time of the trustor´s death.
A living trust of this type should be distinguished from other kinds of land trusts – for example, a pure anonymity/asset protection trust that has no probate objectives, or an investor trust that contemplates short-term acquisition of investment property or a transfer of ownership of non-homestead property by means of an assignment of beneficial interest (referred to by us as "entry trusts" and "exit trusts," respectively). These other trusts are discussed at length in our companion articleLand Trusts in Texas.
The living trust is a tried and true means of avoiding probate court for the homestead and, if the trustor is married, skipping a potential taxable event upon the death of his or her spouse. Tax implications change continually, so consult with your tax advisor to determine the actual effects in your case (This office does not give tax advice – our focus is probate avoidance and asset protection). Our view is that a living trust should be considered (along with a "pour over" will) as part any middle class estate plan.
A living trust for the homestead is an excellent way to achieve a variety of positive results independent of measures one may be taking to protect investment properties. Again, the emphasis here is on probate avoidance and not asset protection. Why? Because homesteads are already protected in Texas from forced sale to satisfy judgments (see Art. XVI, Sec. 50 of the Texas Constitution and Texas Property Code Chapters 41 and 42). So it is useful to generally distinguish between homestead-exempt assets (protected by statute) and investment assets (which are unprotected).
Should living trusts be used for the long-term holding of investment properties? No, because trusts have no liability barrier as do LLC´s. The LLC, in particular the Series LLC, is better suited to holding investments.
There are three possible parts to the living trust process: (1) establishing the trust with a signed trust agreement (unfiled); (2) executing and filing a warranty deed conveying the home into trust; and (3) execution of a "pour-over will" to move miscellaneous assets into the trust upon death. An additional option is to arrange for life insurance to be payable to the trust. A checklist of information needed to draft a living trust is included at the end of this article.
Creating the Trust
The person creating the trust is called the "trustor" or "grantor." This is the person who establishes the trust and conveys property into it. A trustee (or co-trustees if husband and wife) is/are appointed to direct trust affairs on behalf of the beneficiaries (usually the trustor and spouse) and, upon the death of the last primary beneficiary, on behalf of one or more contingent beneficiaries (usually children). Since title remains in the trust, and the trust does not die, the surviving beneficiaries "inherit" the trust property but without probate or other involvement by courts or lawyers. All that changes are the percentage beneficial interests in the trust.
The document that creates the trust is called a trust agreement or declaration of trust. It should state the trust´s purpose in general terms along the following lines: "to hold, preserve, maintain, and distribute the Trust Property for the benefit of the Beneficiaries, including but not limited to payment of expenses for their respective health, education, maintenance, and support as the Trustee, acting in his or her sole discretion, deems reasonable, prudent, and necessary."
Statutory authority for creating trusts is found in the Texas Trust Code, which is contained in Chapter 101 of the Texas Property Code. The trust agreement may expand upon or limit these statutory provisions.
The trustee is charged with management of the trust and has the authority to act on its behalf. Texas law confers wide powers upon a trustee, including selling and purchasing trust property. Usually, the trustee is same person as the trustor. It is possible to name co-trustees (e.g., husband and wife) and this is recommended to provide for a smooth succession in the event one spouse dies. A successor trustee should also be designated in the event the last trustee becomes unable or unwilling to serve.
The trustor, trustee, and beneficiary may not be identical (pursuant to the "doctrine of merger") or the trust evaporates as a matter of law. The trustee may not be a corporation or LLC.
The trustor should reserve the right to revoke or amend the trust. The terms of the trust are therefore not finally fixed until the trustor dies (or, in the case of husband and wife co-trustors, when the surviving spouse dies) at which time the trust becomes irrevocable and the beneficiaries automatically succeed to the entire beneficial interest. No deed or probate is required at that time. Even though Texas has an expedited probate process, the results may be a considerable saving of time, effort, attorney´s fees, and court costs.
Trust property may include any type of property, whether personal or real, tangible or intangible. Additional property may be transferred into the trust at a later date, after the trust is established.
The trust need not assume existing liabilities on trust property in order for the transfer to be effective. Property can be taken "subject to" existing indebtedness (i.e., without the trustee taking any liability for the debt), or such indebtedness can be "wrapped" (See our article Wraparound Transactions in Texas).
Real property is conveyed into the trust by general or special warranty deed (see our article Deeds in Texasfor the distinction), which is recorded in the county clerk´s real property records. The deed should make certain specific recitals concerning the homestead nature of the property. Conveying the property by deed into the living trust is an essential part of the process since the trust agreement, by itself, does not transfer title.
The trust agreement, unlike the warranty deed that accompanies it, should not be recorded. It is a private and confidential document. Its terms need not even be disclosed to the beneficiaries. A brief "Summary of Trust Terms" or "Memorandum of Trust" is occasionally prepared to provide to third parties if deemed necessary by the trustee.
A "spendthrift clause" should be included that prohibits a beneficiary from assigning his or her interest in the trust to creditors.
Note that transferring property into a revocable trust does not reduce a trustor's assets for Medicaid purposes. Trust property is still counted by Medicaid as belonging to the trustor.
Mixing Anonymity Techniques with Living Trusts
The traditional way for a trust to hold property is in the name of "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" – an anonymity technique occasionally used for investment property. After all, county clerks have no problem recording a deed into the name of a trust which does not expressly name the trustee, so long as the trustor´s/grantor´s signature is properly acknowledged. Although this may work in the case of anonymity trusts for investments, the risk of utilizing anonymity techniques in the case of a living trust for the homestead is that a title company may – upon later sale – take the strict legal view that trusts are not proper legal entities (true) and declare the deed into trust void. At that point it may be too late to go back and reform/refile the deed into the trust. Why? Because, in the case of living trusts, such matters are likely to become an issue only after the trustor/trustee is deceased and therefore unavailable to sign. Accordingly, a trustee should always be expressly named in the deed.
Preserving the Homestead Tax Exemption
The Trust Agreement should contain language that preserves (1) homestead protections available to Trustor pursuant to Art. XVI, Sec. 50 of the Texas Constitution and Texas Property Code Chapters 41 and 42; and (2) any available homestead tax exemption whether currently on file or not. It is prudent to make these recitals even though the 81st Legislature in 2009 added Property Code Sec. 41.0021 stating that transfer of a residence into a "qualifying trust" retains the homestead character of the property.
Similar language should also be recited in the deed into trust so as to make it clear to the local taxing authorities that a living trust has been established for the homestead.
Federal Income Taxes
Since a living trust is a revocable and amendable instrument, it is recommended that one not procure a tax identification number for the trust or attempt to file separate trust tax returns (This is more often done for irrevocable trusts). Forming the trust should not affect how the trustor currently files a federal income tax return; however, this firm does not give tax advice. Consult your tax advisor to determine what is best for your specific circumstances. Generally, a client is best served if he consults both a capable attorney and a good C.P.A. in connection with real estate transactions.
Comments on Due-on-Sale Clauses
What exactly is a due-on-sale clause, and does it represent a problem for living trusts? A due-on-sale clause enables a lender, at its election, to accelerate a note in the event the property or any interest in the property is sold or transferred. Note that there is no such thing as Abreaching or Aviolating a due-on-sale clause. This is an enabling clause that gives the lender the option of acceleration if the lender chooses to do so. Generally speaking, if a transaction involves a title transfer without prior consent of a lender that holds a note and lien on the property, then the risk of acceleration is present if the lender´s deed of trust contains a due-on-sale clause and the lender´s prior consent is not obtained.
However, in the case of living trusts for the homestead, there is an express exception to due on sale. Here´s how the typical due-on-sale clause (found in paragraph 18 of the Fannie Mae/Freddie Mac Uniform Deed of Trust) is worded:
If all or any part of the Property or any Interest in the Property is sold or transferred (or if Borrower is not a natural person and a beneficial interest in Borrower is sold or transferred) without Lender´s prior written consent, Lender may require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if such exercise is prohibited by Applicable Law.
What is Aapplicable law? The relevant statute is the Garn-St. Germain Depository Institutions Act (U.S.C. Title 12, Chapter 13, Sec. 1701j-d) which reads in part:
This is the federal living trust exception, which was intended to create an exception to enforcement of due-on-sale clauses in connection with transfers of property to family trusts designed to avoid probate (Note that this exception is not intended to apply to investor trusts dealing with non-homestead property). More detail on this subject is contained in our article, Due on Sale in Texas.
. . . a lender may not exercise its option [to accelerate the note] pursuant to a due-on-sale clause upon . . . (8) a transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property.
It is good practice for the trustor to execute a last will and testament that contains "pour over" provisions designed to convey into the trust any property that was not previously designated as trust property. In this way, the trust and the will work together as part of an overall strategy. It is also possible to have life insurance paid directly to the trust. This may be advantageous for purposes of paying off liens on the homestead.
The Role of the Title Company
Note that if and when the property is sold out of the trust (usually after the death of the trustor) the title company will probably want to see the trust agreement. Once again, it is important that the trust be properly drafted so a Texas 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 can be a hassle and defeat the purpose of creating the trust in the first place.
Many title companies lack adequate knowledge of basic trust law and practice. It is occasionally necessary for the trustor´s attorney to discuss the trust with the title company closer or attorney in order to educate him or her as to the nature and effect of the trust.
To facilitate a title company´s cooperation, the trust agreement should include release and indemnity language that a title company may rely upon in issuing title insurance. In rare cases, if all of the foregoing measures have been unsuccessful in obtaining a title company´s cooperation, it may be necessary to change title companies. For more information on the services provided by title companies, see our companion article entitled Title Insurance in Texas.
Using an Attorney to Draft and Maintain the Trust
Clients occasionally ask for a "standard" trust – or worse, a fill-in-the-blank form – neither of which exists at any acceptable level of quality, and that includes "trust kits" available on the internet. Anything in this category is likely junk. There is no substitute for the analysis and advice of a competent professional in this complex area of the law, especially when it comes to making the trust effective in a state like Texas where there are unique and specific laws relating to homestead property. The challenge for the attorney is to discover what the client is trying to achieve and then tailor a document to suit specific needs.
It is also useful to have an attorney to assist with changes in trust property or amendments to trust provisions that may occur over the years after the trust is established – especially if one homestead is exchanged for another or if the names of beneficiaries change. Trust maintenance over the years can be as important as trust formation.
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. The law changes. 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. 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.
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 web site, http://www.LoneStarLandLaw.com.
CHECKLIST FOR PREPARATION OF LIVING TRUSTS
Please complete this checklist and send it to us for preparation of the trust. It is suggested that you first read our article Living Trusts in Texas which can be found at www.LoneStarLandLaw.com. Much customization is possible in drafting these trusts, so try to be specific about your instructions. There is a space for filling in any special requirements you may have. Please use email as much as possible to avoid phone tag. The address is LoneStarLandLaw@aol.com.
While living 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:
- The Trustor (sometimes called the Grantor) is the current title-holder to the property. The Trustor is therefore the person/entity who transfers property into the trust.
- The trust "corpus" (or trust estate) is the real property that is conveyed into the trust. Note that the Trustor is also the "Grantor" in the warranty deed conveying the property into the trust.
- The Trustee (which cannot be an LLC) is the manager/administrator of the trust with authority to manage, maintain, and sell the trust property.
- The Successor Trustee serves if the Trustee dies, resigns, or cannot otherwise serve.
- The Beneficiary is the true "party in interest," the one with "ownership" if you want to use that term very loosely.
- The Contingent Beneficiary takes the beneficial interest if the original Beneficiary dies (This applies only if the Beneficiary is a natural person, not an LLC).
In order for us to draft your trust, we will need to know what persons/entities you want in each role. Make sure that the names you give us are the exact way these persons will sign the trust documents – including middle initials, "Jr.," etc. Note that the same person cannot serve as Trustor, Trustee, and Beneficiary – or the trust disappears as a matter of law according to the doctrine of merger. Read our article Land Trusts in Texas for more details.
Fees and Costs:
Legal fees of $550 must be paid in advance. Payment options are at "Make Payment" on the website.
If you wish us to create a deed conveying the property into the trust – and this is an essential part of this two-step process – then please email a copy of the existing warranty deed or fax it to (832) 201-5321. The fee for deed preparation is $225 exclusive of county clerk filing fees which vary across Texas. Note that we recommend that the deed contain specific, custom language pertaining to the trust property and its status as homestead.
1. What is your purpose in creating this trust?
______ probate avoidance/estate planning
______ asset protection through anonymity
______ other (explain): ___________________________________________________
2. What is the name and mailing address of the trustor (the name of the person or persons who will be conveying the property into trust)? Normally this is/are the name(s) in which the property is currently held, according to the existing deed.
Mailing Address: ______________________________________________________________
3. If the trustor is married, but the property to be put in trust is currently titled only in the trustor´s name, then what is the name of the trustor´s spouse?
4. What is the street address of the property to be put in trust?
5. What will be the name of the trust? One possibility is to use some variation on the address – e.g., "The 123 Oak Street Family Trust." But the choice is yours.
6. What is the name of the trustee (i.e., the person who will manage the trust)? If there are going to be co-trustees, then list both names as they should appear on the trust document.
If there are co-trustees, then:
______ either trustee may act alone on behalf of the trust.
______ both signatures will be required.
7. Who is the successor trustee? This is the person will serve if the trustee is deceased, disabled, or declines to continue to serve.
8. Who are the beneficiaries? Usually these are listed as the trustor and spouse or the survivor thereof.
______ trustor only
______ trustor and spouse. Spouse´s name is: ______________________________________
9. Who are the "contingent beneficiaries?" Usually these are the trustor´s children.
10. Special Provisions (anything else the attorney should know?):
11. Do you have a last will and testament? An estate plan is not complete without a will. If you choose not to prepare a will at this time, you should put it on your "to do" list for the near future.
Name of person completing this checklist:
Phone: __________________ Fax: __________________