This article is Part 2 of a four-part series on Land Trusts. You can find Part 1 here: Understanding Land Trusts
Investors, attorneys, or CPAs unfamiliar with the use of land trusts often ask me “why would someone consider using a land trust?” My general response is “why not.” When it comes to entity structuring many people prefer to being with the complex rather than the simple. The land trust, contrary to the multiple internet gurus or guest REIA speakers that sing the vestibule of virtues offered by this rudimentary of tools, is simply and nothing more than a title holding vehicle with some interesting attributes. From a legal standpoint, the land trust is a type of “grantor trust” (this is the phrase you should use in states that don’t formally recognize land trusts via statute).
There are many types of grantor trusts, including living trusts and personal property trusts, all with generally the same purpose: to shift the title of property out of your name and into the care of a trustee.
How does a land trust work? There are three basic parties involved:
- The Grantor: This person who sets up the trust and transfers assets into the trust.
- The Trustee: The person who manages the trust. The trustee should have actual duties so the trust isn’t a passive trust. However, the grantor can name himself trustee if he wants to, but I recommend using another person. Of course you must trust that person. I will cover this later.
- The Beneficiary: The beneficiary is usually the grantor — he gets the “beneficial interest”, i.e. ownership, of the trust. Think of this like stock in a corporation. It is personal property and has all of the ownership rights associated therewith. This will also be covered later.
From a practical standpoint, think of the land trust like a box with its sole purpose to hold real estate. The box comes with a set of instructions for the trustee and the beneficiary. These instructions detail who has the power to lease, sell, or encumber the property. The instructions can also specify how distributions of income will be managed. In short, the land trust’s appeal is in its simplicity and functionality.
Here is an example of how a trust can be structured for a joint venture:
Kevin, a property rehabber, took a serious hit to his credit and financial new worth when the real estate market crashed in 2009. Despite his setback, Kevin is aware of the new opportunities presented by the crash, but he lacks the cash and credit worthiness to purchase a house. Kevin approaches his good friend James and suggests they purchase a house together. James will use his excellent credit to purchase a house and Kevin will use his builder skills to rehab the house so they can sell it for a nice profit.
After the sale closes, Kevin asks James to deed him 50% of the house. Kevin is thinking ahead and wants to protect his 50% interest in the house before he begins the rehab work. James is uncomfortable deeding 50% of the house to Kevin for fear the bank will discover the transfer and call the loan due. James is also concerned that if he makes Kevin a 50% owner he will only receive back half of the $35,000 he put down to purchase the house. Kevin and James are at an impasse and the project stalls.
Kevin and James’s problem is not knowing how to structure this deal to address each parties concerns. Most attorneys would likely recommend an LLC but this would not address James’s issue with the due on sale clause because a transfer of encumbered property into a LLC is not exempt from a lender accelerating the note. The solution for Kevin and James is a properly drafted land trust wherein Kevin and James will each own 50% of the trust i.e., trust beneficial interests. The trust could be drafted so the first $35,000 received from the sale of the house will be allocated to James and all remaining proceeds will be split equally between the parties. The bank will not discover James transferred 50% of his ownership to Kevin via the trust because only the deed transferring the property into the trust is recorded. Thus, both Kevin and James are able to move forward with their investing having solved their initial impediments to making money in real estate.
Kevin and James is just one possible benefit from using land trusts. I have found the use of land trusts are only limited by the real estate investor’s creativity. A land trust can be used in just about any real estate transaction; but for most real estate investors, it is commonly used for the following purposes:
- Avoiding the due on sale clause when encumbered property is transferred
- Providing privacy of ownership
- Avoiding county transfer taxes
- Wholesaling property or purchasing property subject to an existing loan
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In part 3 of this series on Understanding Land Trusts I'll address the “Due-on-Sale Clause“ and explain in detail how the land trust will help you. We will also complete the discussion explaining the privacy of ownership, avoiding county transfer taxes, and wholesaling property or purchasing property subject to an existing loan.