DAVID J. WILLIS ATTORNEY
Copyright © 2018. All rights reserved worldwide.
LAND TRUSTS IN TEXAS
With Comments on Anonymity and Asset Protection
by David J. Willis, J.D., LL.M.
In Texas, a "trust may be created for any purpose that is not illegal" (Tex. Prop. Code sec. 112.031). There are many kinds of trusts and most of them can be adapted to hold real estate, whether investment property or the homestead. The difference between types of trusts revolves around their intended purpose, so one needs to be clear about goals before setting out to utilize a land trust. This chapter 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 the asset for a longer term.
The scope of this article is limited to living trusts (meaning trusts formed during the lifetimes of the participants) for the purpose of holding investment or homestead real estate. Testamentary trusts, which take effect upon the death of the person creating the trust, are part of the estate planning process and can be substantially different, often because of tax issues—so consult an appropriate expert for advice on those. Living trusts designed specifically for the homestead are the focus of a different article.
Types of Land Trusts
Transactional trusts include:
entry trusts, used by an investor to acquire a property to be flipped using an assignment of beneficial interest; and
exit trusts, used by an investor to “sell” property to a buyer who is working to restore credit and obtain traditional financing.
Holding trusts include:
anonymity trusts, which hold an asset under the trust’s name with no reference to a trustee or underlying ownership; and
living trusts for the homestead, principally a probate-avoidance device.
Clients often ask attorneys for a "standard" trust (or worse, a fill-in-the-blank form they can use themselves) 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. Because trust agreements can be written in so many different ways, 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, there are certain structural items that do not change:
(1) The trustor (sometimes called the settlor or grantor) is the current title-holder to the property. The trustor is therefore the person or 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 generally 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. An LLC can be a beneficiary.
(6) The contingent beneficiary acquires the beneficial interest if the primary beneficiary dies (note that there would be no need for a contingent beneficiary if the beneficiary originally named is an LLC).
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. Note that "a trust terminates if the legal title to the trust property and all equitable interests in the trust become united in one person" (the doctrine of merger found in Property Code section 112.034). So the person or persons acting in each of the three main roles cannot exactly match.
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 (these are our terms and categories). Both types are popular.
In the case of an 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 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 (almost always a bad idea) that allows the investor to a share of 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 for investors 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)
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. "Seller" and "buyer" are loosely-used terms in this context since there is no deed being executed into the end user at closing. Title is placed in the trust. The property is conveyed into trust by general warranty deed and the buyer takes immediate possession. The trust acts as a temporary parking place for title to the property while the buyer works to obtain 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 argue 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/seller'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.
As noted, there is no deed, recorded or unrecorded, into the name of the buyer, since he or she is not acquiring actual title to the property at the time the trust is created—only the option to buy a personal-property beneficial interest. Ultimate transfer of title to an end user is deferred until credit repair and third-party financing are completed. 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 the warranty deed. The trust agreement is not recorded. In order to achieve maximum anonymity, the name of the trust should be generic.
There are no published cases on the success or failure of this type of trust as a long-term investment strategy. There is a degree of risk associated with a judge looking carefully at it, and perhaps using the sword of justice to slice through the Gordian knot of complexity, leaving (in the court's view) an executory contract that fails to comply with Property Code 5.061 et seq. That's the principal exposure on the legal side.
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 for investors. 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, it does. One may make a rational argument that an exit trust is not an executory contract, but the same cannot be said for a claim that such a trust does not constitute seller financing.
Exit Trusts as an Alternative to Lease-Options
A well-drafted land trust may provide an alternative to lease-options, which are expressly defined to be executory contracts. And generally speaking, executory contracts in residential transactions are difficult (if not almost impossible as a practical matter), just as the legislature intended.However, one can argue to a judge with a straight face that a land trust falls outside executory contract rules so long as the trust agreement provides for an option to purchase a beneficial interest in the trust (which is personal not real property) rather than an option to purchase the real property itself.
Use of an LLC in Combination with a Trust
Trust law in Texas falls under the Property Code, whereas the law of business entities (LLCs and corporations) falls under the Business Organizations Code. That gives us a clue as to the respective function of these entities. Trusts can hold property, of course, but there is no liability barrier against lawsuits as is true with entities formed under the BOC. Even if property is held in an anonymity trust, the trust—including the trustee as well as other participants in the trust—are still individually and personally exposed, an undesirable result given the propensity of plaintiffs' attorneys to sue every name they can find that is connected to the transaction. Utilizing an LLC as the beneficiary of a land trust can insert a layer of liability protection.
The Anonymity Trust
Use of an anonymity trust (our term) is an edgy technique that must be implemented carefully and by planning ahead. A trust agreement 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 of the 123 Oak Street Trust;" however, it is possible to list the grantee as only the trust—e.g., the "123 Oak Street Trust"—with no reference to a trustee. Anyone seeking to know who the principals are and what assets they have has their work cut out for them since trust agreements are generally private, unrecorded documents. County clerks will accept such a deed for filing in the real property records so long as it is properly executed and acknowledged by the person conveying the property into the trust, but filing is not the problem. Issues arise later when the investor decides to transfer the property out of trust, since no trustee was named in the deed who can now sign as grantor.
Accordingly, users of anonymity trusts should anticipate objections from a future title company based on the proposition that a trust is not a legal entity—which it technically is not. One should accordingly be prepared to re-execute and re-record a deed which includes the name of the trustee. A wiser alternative would be to expect this obstacle and have a deed already signed and notarized, previously held back in reserve, but now ready to hand to the title company upon demand. This solves the problem while preserving anonymity in the interim.
A development in favor of anonymity is Property Code sec. 113.018, added in 2017, which permits a trustee to appoint an agent and grant the agent powers "to act for the trustee in any lawful manner for purposes of real property transactions." The agent can be anyone so long as the appointment is in writing and notarized (there is no requirement that it be filed). The appointment – or "delegation" as the statute puts it—can be supplied on demand to third parties as evidence of authority. It is valid for six months.
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 must also be properly written and executed so that it will be accepted as valid. Otherwise, the title company may choose to ignore the trust altogether (i.e., acting as if it never existed) and require signatures from all persons having an actual or potential interest in the property. An alternative would be to require a judicial determination of heirship. Both of these outcomes will likely defeat the purpose of creating the trust in the first place.
If for privacy reasons an investor is reluctant to show the entire trust agreement to the title company, then Prop. Code sec. 114.086 provides for an alternative: a "certification of trust" (also commonly called a memorandum of trust) that is a concise summary of material trust terms. So long as the information required by the statute is contained in the certification, "A person who acts in reliance on a certification of trust without knowledge that the representations contained in the certification are incorrect is not liable to any person for the action and may assume without [further] inquiry the existence of the facts contained in the certification. Tex. Prop. Code sec. 114.086(f). A title company is not compelled under this law to accept a certification of trust in lieu of the actual trust agreement, but liability to third parties may be avoided if the title company chooses to do so.
One should expect a requirement that any assignments of beneficial interest will have been recorded.
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 hesitant 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 false. A principal defect of trusts marketed over the Internet is failure to consider or comply with Property Code section 5.061 et seq. 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.
However, since the real estate crash, title companies have become suspicious, if not outright hostile, to land trust transactions, so this is a factor that must be considered when considering the use of land trusts (anonymous or not) as a principal feature of one's business model. They are perhaps better left to the occasional transaction which suits their use.
Information in this article is provided 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 © 2018 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.