SHOULD YOU WEAR SUSPENDERS WITH YOUR BELT?
ASSET PROTECTION VIA THE CONTEMPORANEOUS USE OF THE LAND TRUST…’AND THE LIMITED LIABILITY COMPANY (‘UM…’FOR THOSE IN RIO LINDA, “CONTEMPORANEOUS” MEANS: HAPPENING AT THE SAME TIME)
Having been in the land trust transfer and facilitation business for nearly thirty years now, we get frequent questions from our clients and students around the country regarding comparing the (Illinois-type) land trust with the limited liability company (the LLC) as which might be the preferred asset protection device with regard to real estate holdings. My response is always the same: An LLC will protect YOU; the land trust will protect YOUR PROPERTY, and when used together the protections of both are enhanced and your real estate holdings can be virtually “armor-plated.”
But irrespective of what the answer might be, never forget that: “In today’s litigious society, holding real estate in your own name is tantamount to walking down “Starving Lawyer Boulevard” with a bullseye on your back above the words: ‘I dare you! Sue me! I’m worth it! I own real estate, ‘so I must be really, really rich.”
The LLC is a limited liability company (‘not a corporation) that combines many of the features of a corporation, but which is more akin to a sole proprietorship or partnership, depending upon the number of members. In comparison, the LLC, as a pass-through tax entity affords its members simplicity in tax accounting and reporting.
Beyond those features, however, the LLC’s primary purpose is that of shielding its member-owners from any litigation that would befall the company and its assets. In other words, were an LLC to be established for the purpose of operating a packing plant and someone were to slip and fall into a meat-grinder and loose a couple legs, the claimant’s legal recourse (.e.g., ‘were he to have “a leg to stand on”) would be limited to the assets of the company, and not to any other assets owned by its operators (“members”) outside the company. Even is the business were to be taken over, or closed down and liquidated by a victorious claimant, ‘the owner’s home, golf club memberships, automobiles, furniture and private bank accounts would remain beyond of the reach of the lawsuit.
Relative to the article you’re reading now, bear in mind that any company in operation could, ‘should it so choose, hold as its only asset, a single house, condominium, townhouse or apartment building…of several of them. In any of these vehicles: an LLC, LP (limited partnership) or FLP (family limited partnership)…all of which protect their members (owners) from claims against themselves personally…’and are considered by many to be the most ideal forms of small business ownership.
[For additional info. re. limited liability entities, go to: www.corpnet.com]
AND NOW, ‘THE TITLE-HOLDING (“ILLINOIS-TYPE”) LAND TRUST:
Much has been written in the last twenty or thirty years about the feasibility, functionality and versatility (‘and safety) of the “Illinois-type” Title-Holding Land Trust as an alternative means for owning, dealing in and protecting real estate. Be that as it may, however, there continues to exist a major lack of knowledge as to what a land trust is, its uniqueness, and any real understanding by the legal profession i.e., of all that it can do for property owners.
For example, very few attorneys are aware of, and will argue in ignorance against, the fact that when a property is placed into such an entity, its real property ownership becomes solely that of the third-party trustee nominee, and the beneficiary/ies’ ownership is equitably converted to ownership of personal property [see the Doctrine of Equitable Conversion]. By this process both the property’s legal title and equitable title are vested in the appointed trustee, leaving the grantor/beneficiary with only a personal property interest in the trust, without ownership of the property itself: however…’be tht as it may the settlor retains the equivalent of fee-simple ownership none-the-less, ‘along with complete directive-control over the actions of the trustee.
Once vested in the land trust trustee, the property’s true legal and equitable title ownership is solely that of the trustee (‘one’s careful selection of trustees being crucial).
In such “equitable conversion,” the properly structured land trust provides its beneficiaries with all the protection that the law affords both real property owners AND personal property owners (‘i.e., limited partition rights by outside judgement creditors; anonymity of ownership; inability of judgment creditors (including the IRS) to reach the co-beneficiary land trust in order to lien its corpus (‘the property); the avoidance of a lender’s due-on-sale admonitions upon fractional transfers of beneficial interest (‘assuming that the borrower/transferor is a “natural person” under the law…i.e., ‘not a commercial enterprise (i.e., a corporation) to whom the loan was made and by which entity it is guaranteed).
Also note that inasmuch as one’s ownership in a title-holding trust is personalty and not realty there is no compromise of recent Dodd-Frank prohibitions regarding owner-financing of real estate (‘i.e., re. the Wall Street Consumer Financial Protection Act).
It is also too infrequently realized by attorneys (‘even real estate specialists) that land trusts per se are legal in all states, ‘although officially recognized only as “Use in Land” versus “Uses in Trust” in Louisiana and Tennessee. What this means is that in these two states, landtrust are not illegal,but that ownership of beneficiary interest in a land trust is seen as equivalent to ownership of the real estate, and any errant tenant co-beneficiary would have to be judicially foreclosed upon, rather than being evicted (‘as is the case in other jurisdictions), ‘i.e., in order to rectify a contract violation (‘such as, say, a payment default).
By use of the land trust model described here, one can, by a simple assignment of beneficiary interest, easily transfer all or a portion of a property’s ownership benefits (‘i.e., w/r to four or fewer units) to another party with one brief assignment document. I.e., without (necessarily) any need for a new loan, specific down payment or credit requirements, escrow, new title insurance, credit approval, underwriting…or other lender involvement.
When a property’s title is held by a trustee-nominee for a third-party, co-beneficiary land trust, the property is, throughout the trust’s term, essentially in a state of “escrow,” meaning that during the trust’s stipulated term no single beneficiary can act unilaterally (‘i.e., ‘without the unanimous consent and direction of all beneficiaries acting in concert).
As well, (and where we come in) a co-beneficiary in a bona fide land trust can in-fact be appointed to lease the property from the trustee, and when given at least a ten-percent beneficiary interest in the trust, receive full tax treatment by the IRS as a homeowner regarding all income tax deduction benefits of mortgage interest and property tax deductions (IRC §163(h)4(D) & IRR #92-105), along with §1031 tax exchange and §121 exemption and exclusion benefits remaining fully intact.
Now…’couldn’t a person (yourself, for instance) armed with this information advocate placing its real property into a land trust and naming his/her LLC as a co-beneficiary in order, not only to shield it from public view, but also to hold it beyond the reach of potential judgment creditors (‘including the IRS), and to avoid transfer tax?
In effect, the title-holding land trust which is the basis for the proprietary Equity Holding Corp. Title-Holding Land Trust Transfer™ shields the property,while the LLC shields the beneficiaries…’i.e., from litigation and the leering eyes of hungry lawyers and the spittle-dripping fangs of irascible judgement-seeking creditors. (Sorry…’got carried away there. I love creditors..’but only when I am one).
Frequent Question: Which is better? An LLC or a Land Trust for Holding Income-Producing Real Estate?
- Unlike an LLC or a corporation, ‘vesting a property in the trustee for a land trust does not trigger the imposition of reassessment for property tax, nor does doing so incur transfer tax or tax stamps in any state. Neither does the land trust violate the lender’s due-on-sale admonitions, or compromise the recent Dodd-Frank legislation re. seller-financing restrictions.
- Unlike as is the case with an LLC, the beneficiary of a title holding (land) trust receives the benefits of an IRS §1031 tax-deferred exchange, and/or the section §121 home sale exclusion, without regard to a particular “Continuity of Transfer” requirement (See below)
As noted earlier, an LLC, may be (‘should be when practical) made a beneficiary of the land trust or specifically, the Equity Holding Trust Transfer™: ‘i.e., ‘with the managing member of the LLC, holding the Power of Direction over the trustee (‘e.g., holding the power alone, or sharing it with co-beneficiaries). The reason for structuring the transaction in this manner is that when the transaction’s primary goal is protection for beneficiaries from tort liability, the “naked” land trust alone can be made more effective and protective when coupled with the LLC as a co-beneficiary, which LLC is funded by the personal property beneficiary interest in the trust, rather than real estate.
And here’s why:
Due to a gap in knowledge on the part of many beginning, and some seasoned, investors (‘and their too-often naïve legal advisors), ‘they are either oblivious to this important tool, ‘or they tend to set it up incorrectly. Unfortunately, the trouble arising from the lack of experience and knowledge probably won’t present itself until much later (‘more often than not…’too much’ later).
Consider the case of Attorney Herkimer Phlurm (‘maybe not his real name) who sought to help an investor client protect his rental property from the risk of liability claims. The investor asked the attorney, how he might best protect a recent purchase of an income property from threats of litigation.
Short on knowledge of trusts, ‘but long on experience in structuring corporations, partnerships and Limited Liability Companies (LLC’s), ‘the attorney created a nice little LLC for his client in which to hold title to his new property. Following creation of the entity, and after recording the property’s deed, ‘both, Attorney Phlurm and his client, Rupert Schlitzberg (probably not his real name either), were pleased with the arrangement…’for a while (‘…but any ecstasy was short-lived).
In another year, Mr. Schlitzberg (“Rupert” to his friends) was shocked when he received an excise (transfer) tax bill from the county tax assessor’s office. Surprise!
As attorney Phlurm might have anticipated and informed his client, ‘the vesting of his property in the LLC triggered a transfer-tax ($2-3,000), ‘in that the property was security for a mortgage at te time, and…’what’s more…‘the transfer to the LLC constituted a clear breach of the lender’s Due-on-Sale Clause (12 USC 1701-j-3), ‘thereupon opening the door for foreclosure on the mortgage ‘should the lender opt to do so (…at any time at all in the future…’obviously leaving the Schlitzbergers on “tenterhooks,”* as it were).
*Tenterhooks,” the expression comes from a tent maker’s extreme stretching of newly woven canvass over a square frame with heavy hooks lining all four sides and then wetting, shrinking then drying the material before coating it with waterproofing (‘See how much you can learn by hanging out with us?)
And…‘not only that… (‘Wait! there’s more), ‘the change of ownership also constituted full justification for reassessment by the county tax collector and quite likely, an even larger tax bill next year.
In one fell swoop there was: 1) taxation on the transfer; 2) violation of the lender’s due on sale clause; 3) triggering of county reassessment, and 4) imposition of restrictions regarding IRC §1031 exchange provisions (re. Continuity of Transfer).
The major error in this scenario was simply the lawyer’s being unfamiliar with the uses, benefits, features, advantages and nuances of land trusts ‘within the jurisdiction where the property was located. In this case, the attorney’s oversight not only cost the client thousands of dollars, as well as jeopardizing other aspect of the real estate transaction: it also, as well cost the attorney a client. While Mr. Phlurm sits scratching his head, wondering what happened, his client is out seeking a new and better informed lawyer.
MORE ON DISADVANTAGES OF THE LLC WHEN USED ALONE:
LLCs are usually subject to self-employment taxes. This means that the profits of the LLC won’t be taxed at the corporate level, but will pass through to its members who will account for those profits on their personal federal tax returns. Oftentimes, these taxes are higher than they would be at the corporate level. Individual LLC members will pay for federal items like Medicare and Social Security.
Frequent Confusion With Company Roles:
Whereas corporations have specific roles (like directors, managers, and employees), LLCs generally do not. This makes it difficult for the company and especially investors to know who’s in charge, who can sign certain contracts and who can bitch at, or fire, whom.
Although reasonably compensated-for in a properly drafted Operating Agreement, in many jurisdictions, if an LLC member leaves the company—unlike as is the case with a corporation (or a land trust whose identity is unaffected by the comings and goings of “shareholders”) the company structure and its liability protection cease to exist.
In most (if not all) jurisdictions, as we have pointed out, the transfer of a mortgaged property into such a “business based” entity (i.e., corporation, LLC, LP, Business Trust or partnership) is fully taxable.
In any jurisdiction, ‘when someone opts to take advantage of the liability protection afforded by the LLC (re. limiting one’s personal liability), an ideal alternative is to fund the LLC with something other than real estate (‘mortgaged or not). In other words, one can vest the property first in a trustee for a land trust: ‘then vest the trust’s personal property beneficiary interest—‘in the LLC (i.e., make the LLC “a” beneficiary). Ergo, the property is now protected by the trust, and the owner is personally protected from liability by the LLC (‘not unlike wearing suspenders and a belt together)…’and…there is no call for reassessment, transfer tax or any other negatives that can be applied to the LLC.
The “Due on Sale Clause”:
Over our thirty years in business, we’ve received numerous letters from clients who reported that their lenders had “discovered the title transfer” (‘i.e., to the land trust trustee), and were claiming their due-on-sale admonitions had been skirted; ‘and that the mortgage was about to be called immediately due and payable (‘…and that mandatory retirement of the loan was imminent if foreclosure was to be avoided).
However, regarding such lender’s demands, ‘in each such case, a registered letter was sent to the lender’s Loss Mitigation and Legal Departments, suggesting simply that they review Title 12 of the US Code of Law, §1701-j-3. In this particular code section it is clearly stated (‘in Law) that a mortgagor (home owner) transferring his/her property to a trustee for a fully revocable, inter vivos (“living”) trust is excluded from recourse provisions under the Federal Depository Institutions Regulations Act of 1982 (i.e. the Garn-St. Germaine Act): therefore, when the borrower remains “a” beneficiary of the trust, ‘and wherein the trust document itself does not convey occupancy right to another (i.e., ‘such occupancy rights may, however, be granted by a separate lease document, so long as the lease is not for a term of more than three-years or contains a purchase option)–there has been no due-on-sale violation!