Print Article

There are many kind of trusts and most of them can be adapted to hold real estate – either the homestead or investment property – as an asset. The difference between types of trusts revolves around the intended purpose. One therefore needs to be clear about what one is trying to accomplish before setting out to draft a land trust. This article will focus on two groups of 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 real estate or other asset. Testamentary trusts – which take effect upon death – are part of the estate planning process and can be substantially different, largely because of tax issues. Consult an estate planning attorney.

This article should be read in conjunction with our companion web article Asset Protection in Texas.

Transactional Trusts:

Holding Trusts:

Clients often call attorneys and ask 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 advice of a competent professional in this complex area of the law. 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:

In order for an attorney to draft a land trust, the client will need to specify which persons or entities will be acting in each role. Note that the same person cannot serve as Trustor, Trustee, and Beneficiary – or the trust disappears as a matter of law (the doctrine of merger).

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) or bill of sale (non-realty).

There are two basic types of transactional land trusts used by 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 (the "Illinois Land Trust"); and (2) an "exit trust" designed to hold title to real estate while a credit-impaired buyer does credit repair until able to obtain a 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. 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 trust is critical. Certain types of these trusts also 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 be able to 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. If asset protection is important, then the grantee on the subject to deed should be the investor´s LLC.

Exit trusts can be a bit complicated. Basically, the trustor (our client, the investor) is the "seller." A credit-impaired "buyer" is designated as a beneficiary of the trust.

The subject property is conveyed into a trust that acts as a temporary "parking place" for the property while the "buyer" takes immediate possession and 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 it is our position that beneficial interests in a trust are personal property, not real property, and therefore do not fall under the lease-option provisions of the Property Code.

Structurally, the exit trust drafted by this office works like this: the trust names a minority (10%) beneficiary, who is the trustor/investor/seller; and a majority (90%) beneficiary (the 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 is not in default.

Note that here is no deed, recorded or unrecorded, into the name of the "buyer," since he or she is not purchasing the property at the time the trust is created – that action is deferred until credit repair is complete. For the time being, the only deed being executed is the deed into the trust.

Using an LLC as a management company – acting through a registered assumed name (DBA) is a good idea. Our view, generally speaking, is that an investor should have two LLC´s – a "shell" management company that does business with the public, and a series LLC that acts as a "holding company" and stays quietly in the background.

Trust law in Texas falls under the Property Code, whereas the law of business entities (such as LLC´s and corporations) falls under the Business Organizations Code (the "BOC"). 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 BOC. The property might be anonymously held, but it – and the participants in the trust – are still 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 a trust alone has no effective liability barrier. Creation of the trust is a private transaction except for the recording of a general warranty deed into the trust. In order to achieve maximum anonymity, the name of the trust should not include the names of any parties to the trust.

Trusts combined with LLC's can present significant hurdles to a plaintiff who wishes to find and sue the property owner. The new Texas series LLC, which allows assets and liabilities to be held in insulated compartments or "series," is the preferred vehicle for real estate investors. See our companion web article LLC´s in Texas – The Series LLC.

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.

A well-drafted land trust provides an alternative to lease-option transactions, the traditional investor favorite, but which are now defined to be executory contracts under Sec. 5.061 et seq. of the Texas Property Code. What exactly is an executory contract? An executory contract includes any transaction that defers some action by either party that pertains to ownership or possession of real property into the future (The classic executory contract is the contract for deed). The net effect of Sec. 5.061 is to make executory contracts unworkably difficult – just as the legislature intended.

How does all of this affect land trusts, in particular the exit trust? Our opinion is that a land trust arguably falls outside the executory contract statute, so long as the trust is worded to provide 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 is usually established as part of a broader asset protection plan. It is a relatively simple document that is executed along with a warranty deed conveying real property into the trust. 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." It is untrue that one must name the trustee in the deed, at least for purposes of recording, since county clerks gladly record such deeds so long as they are property acknowledged. Anyone seeking to know who the principals are and what assets they may have has their work cut out for them. Note, however, that certain title companies object to this approach based on the theory that a trust is not an actual entity under Texas law (true) and therefore cannot hold property if the trustee is not specifically named in the deed; other title companies will, for purposes of subsequent transactions out of the trust, be satisfied with a copy of the trust agreement. The worst case scenario is that the title company you are working with will require that the deed into the trust be re-done and re-recorded naming the trustee. This is a minor inconvenience, since anonymity has nonetheless been preserved during the time of ownership. For most of clients, this represents "mission accomplished."

We are occasionally "lectured" by a title company attorney on this trust issue as if we do not know what we are doing in this area. On the contrary, we know exactly what our goals are and how to achieve them.

A written trust agreement must actually exist for this strategy to work. There are two good reasons for this: as mentioned above, a title company may want 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 agreement behind it.

Investors with multiple properties and/or businesses should consider forming a Texas Series LLC or Nevada Series LLC, both of which offer unprecedented benefits in terms of simplicity and economy.

It is required in the Certificate of Formation that the organizer of a Texas LLC indicate who will be the initial manager of the company. Recently, this firm has devised a creative but approved way to show an anonymity trust as the initial manager, while using an attorney as organizer and registered agent – all in order to achieve anonymity for the client. This is a new and exciting development that requires sophisticated documentation to complete.

Taking the trust concept a step further, it is also possible to utilize a full-scale living trust (more extensive than an anonymity trust in this process) thus providing an excellent place to put the homestead in order to avoid probate. The living trust becomes the sole member and manager of the LLC; it also owns the homestead. Note that this structure would be suitable only for use with the holding company. Again, the virtue of simplicity is served.

The living trust or "inter vivos trust" is a tried and true means of avoiding probate court and, if the trustor is married, skipping a taxable event upon the death of his or her spouse. This author considers living trusts to be an excellent way to achieve a variety of positive results. A living trust should at least be considered by every homeowner as part any middle-class estate plan, period.

It is critical, however, that such trusts be properly drafted so as not to restrict the trustor´s access to and use of trust assets during the trustor´s lifetime. Among other things, this means granting no powers or direction or appointment to the beneficiaries – a common mistake that can cause litigation. All power and authority should remain with the trustor, who also serves as trustee.

Additionally, the trustor in a living trust should reserve the right to revoke or amend the trust. The terms of the trust are therefore not finally fixed until the trustor dies, at which time the other beneficiaries automatically succeed to the trustor´s interest. No deed or probate is required. More detail on these trusts can be found in our article Living Trusts in Texas.

Conveying the homestead into a living trust does not disqualify the property from receiving homestead ad valorem tax treatment.

Note that when the property is sold, the title company will probably want to see the trust agreement. A written trust agreement must therefore exist. Once again, it is important that the trust be properly drafted so the title company will accept it as valid. Otherwise, the title company will likely 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.

Actually, it is astonishing how many title companies are ignorant of basic trust law and practice. It is occasionally necessary for the investor´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. This is another powerful reason to have a knowledgeable attorney working on your behalf.

It is widely advertised that land trusts legally prevent a lender from exercising a due-on-sale clause. True? No, it is not, although acceleration may be much less likely. The explanation for this is somewhat technical. We will try to keep it brief.

First: what exactly is a due-on-sale clause? 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. If the contemplated 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.

Our conclusion? There is no such thing as "breaching" or "violating" a due-on-sale clause. The due-on-sale clause is merely an enabling clause that gives the lender the option of acceleration if the lender chooses to do so. Still doubtful? Take a close look at the wording of the due-on-sale clause found in paragraph 18 of the Fannie Mae/Freddie Mac Uniform Deed of Trust. It is clearly optional language:

What is "applicable law?" The relevant statute is the Garn-St. Germain Depository Institutions Act (U.S.C. Title 12, Chapter 13, Sec. 1701j-(d) 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. It was not, however, designed to provide a safe haven for investors. The truth is that a land trust does not defeat due-on-sale because the transaction contemplates a transfer of rights of occupancy – so due-on-sale provisions remain effective and enforceable. This interpretation is reinforced by FDIC regulations found at 12 C.F.R. 591.5(b)(vi), entitled "Preemption of State Due-On-Sale Laws." See Appendix.

Any trust created for the purpose of falling within the federal living trust exception must meet these stated criteria. Accordingly, the federal exception to lender enforcement of due-on-sale clauses is limited to properties that are owner-occupied. If the owner moves out and someone else takes occupancy, the loan can be called. It is a small but present risk.

For the present, however, this may not matter. Lenders are not generally inclined to accelerate otherwise performing loans, even if a lender knows that the property has been transferred. They are not in the business of foreclosing and owning property. One occasionally sees a letter from a lender threatening acceleration and foreclosure if a new owner does not formally apply to assume the existing loan, but no action usually follows.

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 claim. This author has never seen an internetland trust that is both valid and prudent for use in Texas. A principal defect of trusts marketed over the internet is failure to consider or comply with Texas Property Code provisions pertaining to executory contracts. Some attempt to create liens that are unenforceable in Texas. All of themgenerate 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 is doing in this area.