DAVID J. WILLIS ATTORNEY
Copyright © 2018. All rights reserved worldwide.
ANONYMITY IN TEXAS REAL ESTATE
by David J. Willis, J.D., LL.M.
This article addresses legitimate privacy alternatives for the Texas investor or business person when engaging in real estate transactions. Why is privacy important? First, because information is power, and it is preferable that your opponents have as little power as possible over you; and second, because we live in a litigious world—and offering gratuitous, vital information about yourself in the public domain provides others with a roadmap to your identity, strategy, and assets.
Every day there is a John Smith who files to form an LLC under the name "John Smith Investments LLC" and then lists himself (and often his unsuspecting wife) as initial managers at his homestead address, placing his core personal information in the public domain. Of course this investor does the filing work himself, without assistance from an asset protection attorney, because he is smarter than any lawyer—even though he may have been educated as a software engineer or a medical doctor. After all, the law is easy, right? Just a matter of filling out a few forms?
Guiding rule: every member of the public, every single business partner, every single contract party, every single buyer, every single seller, every single title company, every single attorney, every single vendor, and every single agent or broker should be viewed as a potential adversary in a lawsuit. As long as you have what they want—cash or property—it may be only a matter of time before they come for you. Recognition of this reality should lead sensible investors to proactively limit exposure by implementing an asset protection plan.
Why is there so much litigation? Two reasons: first, because of contingent fee arrangements by which some attorneys take dubious cases and then utilize the legal system to harass legitimate businesspersons into settlement; and second, because the American justice system for the most part imposes no significant penalty upon those who have filed failed or frivolous lawsuits.
Common Questions Pertaining to Anonymity
Three anonymity-related questions frequently present themselves: (1) how can I hold title to property without revealing that I am the true party in interest (this question has to do with status of title—where does true ownership reside)? (2) How can I transfer property held in my personal name to my LLC without showing that it came from me (this pertains to chain of title—what is the recorded link between seller and buyer)? (3) How can I blend anonymity features with the liability shield of an LLC?
When discussing anonymity, two important groups in the real estate world must be considered: county clerks, who maintain the real property records and whose job includes filing documents to reflect chain of title; and title companies, which examine and insure both the status and the chain of title.
Status of Title
Title to property can be held in a surprising variety of capacities—as an individual, a corporation, a limited liability company, a general or limited partnership, in a trust, and so forth—or as a combination of any of the foregoing. Property law is flexible in this respect. What if an investor wants to hold 50% of title in his or her personal name, 25% in an LLC, and the remaining 25% in a family living trust? Not a problem. Whether or not it is wise to structure ownership in such a way is another matter.
Looking past who nominally holds title (determining who is really in control) can be a challenging exercise, but in most cases it is possible to trace this information through the local real property records, DBA filings at the county or state level, or through the Secretary of State and Texas Comptroller—not to mention miscellaneous data accessible on the Internet. The exception occurs when a cautious individual or entity has made a deliberate and diligent effort to remain as anonymous as possible.
So in considering issues of anonymity, one should distinguish between absolute anonymity, which is difficult to achieve in an informed and interconnected world, and relative anonymity, which is a more attainable goal. Think of it as a sliding scale. An effective asset protection strategy seeks to maximize relative anonymity, moving the dial as far as possible in that direction. How far can that be? It depends on the circumstances and an investor's willingness to be creative.
Note that it is possible to purchase, own, and convey property without recording transfer documents. There is no law or requirement that all deeds must be recorded. It is likewise possible to purchase, own, and convey property without ever buying a policy of title insurance or entering the offices of a title company. But the reality is that unrecorded interests are difficult to sell. How would a prospective buyer verify the seller's ownership? Also, buyers in the real world often want title insurance, and their lenders will (by law) require it.
Chain of Title
There is no effective method of defeating, ignoring, or bypassing the chain of title. Each link in the chain of title is represented by a deed or other conveyance recorded in the county clerk's office—and one cannot break the chain and still preserve one's status as record owner. A broken link equals questionable title. Questionable title equals unsellable property.
So what is the response to the question posed above, "How can I transfer property held in my personal name to my LLC (or other entity or person) without showing that it came from me?" The answer is that you cannot, at least not if you are going to be deeding the property to the LLC outright—as opposed, for instance, to using a more creative approach.
One creative alternative is to arrange for the property to pass through one or more intermediate transfers so that its origin is progressively more remote in the chain. The more these intermediate transfers have the appearance of bona fidesales for consideration, the more likely the original transferor is to remain in the background, beyond immediate scrutiny. Again, it is a question of relative rather than absolute anonymity.
Another alternative would be to deed the property into a trust which then privately transfers the beneficial interest in the trust to the LLC. This method has a drawback, however: there is now a trustee (an individual) who is exposed without a liability barrier.
Acquisition of real property begins with negotiation of the earnest money contract, which calls for the name and address of the buyer. Although earnest money contracts are not recorded, they can be the start of anonymity issues, since dealing with realtors, appraisers, inspectors, surveyors, title company personnel, and neighbors is often quite public and leaves an extensive paper trail. Also, people involved in the process inevitably gossip about pending transactions.
There are two advisable choices: either purchase property in the name of an LLC or trust; or, alternatively, list a personal name for the buyer but follow it with the phrase "and/or his or her assigns." The latter provides a means of switching into the preferred method for holding title at the last minute, before closing. This option may be unavailable if the property is financed, since lenders require that the principal obligor on the note and the name of the grantee on the deed be one and the same. In that event, the investor should promptly transfer the newly acquired property into an asset-holding LLC after closing.
Does this raise due-on-sale issues? Unlikely. It is seldom that a lender accelerates a performing loan because it has been transferred into an investor's personal company, but technically it could happen. In actual practice, the potential consequences of leaving investment property in a personal name substantially outweigh any risk involved in moving it promptly into the investor's LLC. See chapter 20 on this subject.
Returning to the subject of earnest money contracts: it is important to realize that contracts can either convey a lot of information or just a small amount of it. Be attuned to this. For instance, is there any reason to list one's home address as opposed to a postal box? A home phone versus your office or cell phone? Do not provide any more personal information than is essential to make the deal. Do not say anything to a realtor that you do not expect to be conveyed to the other side, the realtor's duty of confidentiality notwithstanding. Again, people talk.
Use of LLCs, Corporations, and Limited Partnerships as Transfer Vehicles
Another method of achieving relative anonymity in the chain of title involves establishing a registered entity (an LLC, for example) that is filed with the Secretary of State. The first step, of course, is to establish the LLC; the second is to transfer the property to the entity; the third step involves transferring an interest in the entity to some third person or entity, accomplished by means of a "Sale and Assignment of LLC Membership Interest." The LLC continues to own the asset, but the person owning the LLC will have changed. There would be nothing in the real property records (chain of title) or in appraisal district records that reflects the principals who are now behind the LLC.
Note, however, that filed entities must file an annual Public Information Report with the Texas Comptroller listing the "name, title, and mailing address of each officer, director, member, general partner, or manager" (see Comptroller form 05-102). Eventually, therefore, someone truly determined to discover the real nature of the transfer may do so by accessing the Comptroller's records after the next annual PIR is filed, although this vulnerability may be mitigated by using a trust and certain anonymity layering techniques. Without employing such advanced techniques, the longer-term use of an LLC as a transfer vehicle qualifies only as "anonymity lite."
Limited partnerships are also common anonymity structures, particularly in larger commercial transactions. LPs are often set up as a group of corporations or LLCs with a shell entity as the general partner. These may be owned by other entities. LPs are relatively expensive structures more typically used to buy office buildings and shopping malls. Accordingly, they are beyond the scope of this book and we will not discuss them in detail.
In an anonymity trust, title is taken in the name of, for instance, the "Series A Trust" with no mention of a trustee. While county clerks generally have no problem accepting such deeds for filing, the technical problem is that a trust is not a legal entity that can hold title. Even though trusts often act like legal entities in the real world, a trust is not an entity but a relationship, specifically a relationship between trustor, trustee, and beneficiary, each with rights and duties as a consequence of that relationship.
Accordingly, problems occur when a title company is later asked to insure title as part of a proposed sale of the property. The title company will correctly assert that a deed into an anonymity trust fails as a matter of law, and this is true—even though there has been a deed of record in the trust's name that has successfully preserved anonymity for the investor during his or her entire period of ownership (so the investor's anonymity goals have been substantially achieved). The issue is what the title company will require now in order to move forward, which will usually be two things from the seller: a copy of an acceptable trust agreement or, alternatively, a "certification of trust" pursuant to Property Code section 114.086; and a redeeding of the property with specific mention of the trustee's name.
How to plan for this? The seller should execute two deeds when conveying property into an anonymity trust: one that omits the name of the trustee along with a second one that does—but record only the first one. The second should be held in reserve (a "deed in the drawer" technique) in anticipation of a future title company's objections, ready to be produced and recorded at that time.
We neither encourage nor discourage the use of anonymity trusts of this type. They can certainly be effective. Just note that they are for aggressive investors who do not mind being lectured by a title company and doing redeeding work before sale of the property.
Assumed Name Certificates (DBAs)
Can property be deeded into a DBA as grantee? Does a DBA exist as an entity that can hold property? The answer is no. An assumed name filing is, after all, merely a public notice that a person or entity will be using a different front-name in business transactions. It does not in and of itself establish a new entity, nor is there the equivalent of a trust agreement behind it. The result is that use of a DBA alone to hold title to property likely means there has been no transfer at all. Title insurance would be unavailable for conveyances out of the DBA. Result? This practice is fatally flawed and should be avoided.
Having said the foregoing, it is nonetheless true that assumed names are highly useful devices in anonymity layering. As a rule, each LLC an investor owns should do as much business as possible through its DBA. A bank account should be opened in the DBA name and checks should be printed that way. Leases and contracts should be signed using the DBA. Even though research at the county clerk's office may uncover underlying ownership behind the DBA, an assumed name is nonetheless an important part of the layering process.
Anonymity Using a Two-Company Structure
It is best to separate activities from assets. Assets should be held in an LLC (preferably a series company that stays out of sight and does little or no public business) while dealings with tenants, contractors, vendors, and the like should be conducted by a separate near-shell management company. This two-company structure can be effectively used for anonymity purposes without any add-ons other than the usual assumed names for each company. For instance, the management company can purchase properties (and, in so doing, do business with a seller, one or more brokers, rehab contractors, etc.) and then, after closing and fix-up, transfer the property to the investor's holding company, which is largely immune from a successful lawsuit. Why? Because it has no legal connection (privity) with anyone, meaning it has not conducted business directly with anyone.
As a result of this strategy, the owner of the holding company is relatively remote and anonymous by a couple of steps—not a perfect strategy (none is) but a very good one. In certain cases, it may be useful split the two LLCs between two states, what we call the "two-state solution."
The Hub-Sub Structure AKA the Chinese Puzzle Box
Another alternative is to establish an entity within an entity—an LLC that is owned by another LLC, for instance. If this is your choice, one of our favorite recommendations is to establish a primary operating LLC in Texas (either a traditional or series LLC) which is in turn owned by Series A of a Nevada series LLC. We favor the series format in most cases because of the additional firewall protection between individual series, a significant benefit if an investor has multiple and diverse assets or enterprises.
Mixing Trusts and LLCs: LLC as Beneficiary of a Trust
Benefits can be achieved by mixing a trust and an LLC. There are a couple of possibilities. Before discussing those, it would be useful to answer two common questions: yes, an LLC (or a series of an LLC) can be the beneficiary of a trust; and no, an LLC generally cannot be the trustee. The trustee must be a natural person unless an entity is approved as a trustee by the state (a marathon process involving massive disclosure).
One option is to utilize an LLC as a beneficiary of a land trust. This method consists of three steps: first, creating an anonymity trust, of which the LLC is the 100% beneficiary; second, conveying property into the trust by recorded warranty deed; and third, designating a series of the LLC (Series A, for example) to own and hold a 100% beneficial interest in the trust.
But what about a liability shield? The trustor is usually personally exposed—and this is the principal drawback of this structure (or of any trust), since persons acting as trustees are very often named individually in suits against the trust. This is one reason no sensible lawyer will agree to act as trustee for investment trusts established by his or her clients.
The reader is cautioned against non-lawyer seminar gurus who make overblown claims concerning trusts and asset protection systems they are marketing. Trust agreements available on the Internet should also be avoided. These are almost always of questionable legality and effectiveness. Such schemes are seldom suitable for Texas which has a unique Property Code and Business Organizations Code.
Information in this article is provided for general educational purposes only and is not offered as legal advice upon which anyone may rely. 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. This firm does not represent you unless and until it is retained and expressly retained in writing to do so.
Copyright © 2018 by David J. Willis. All rights reserved worldwide. David J. 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.