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Wednesday
Oct052016

Land Trusts and Asset Protection

Last week, I was a member of a panel of lawyers at Nuview IRA's Planning for Prosperity 2016 conference. Afterward, an attendee asked me how a land trust provides any asset protection since they're essentially just like revocable living trusts which can be pierced easily in a lawsuit. While somewhat correct, land trusts are not like revocable living trusts which are designed to avoid the need for formal probate rather than asset protection. Revocable living trusts usually hold all of a client's real estate rather than just one parcel, and the equitable title in the real estate (the right to lease, sell, encumber and convey the property) remains with the beneficiary while the trustee of the RLT only takes legal title (the name on the official records) to the real estate. Further, the initial trustee of an RLT and the beneficiary of the RLT are usually one-in-the-same person. Meanwhile, a land trust is recommended to hold only one property at a time; all title -- legal and equitable -- vests soley in the trustee so that the beneficiary only has a personal property interest in the trust; and a third-party acts as trustee while the identity of the beneficiary is not disclosed publicly.

This is the biggest asset protection that land trusts provide: our client’s name doesn’t appear on public records as the owner of the asset. That means that, when a plaintiff is considering suing our client for a personal injury or contractual matter, the first thing their lawyer will do is search the records to see if our client owns any assets that could be used to satisfy the judgment. If the attorney finds on Sunbiz that our client is a member of an LLC, and that that LLC then owns multiple properties in the state with little or no mortgage liens, then the attorney will have some hope of recovery of at least something, even if it’s only a charging lien.  If they see our client’s name listed as a member or manager of an LLC, but then find nothing in that LLC’s or the client’s name individually, then the lawyer will point out that fact to the potential plaintiff to let them determine whether it would be worthwhile to sue the client in the first place and obtain a potentially worthless judgment, or whether they’ll prefer to throw good money after bad.

Assuming they move forward with their lawsuit and obtain their judgment against our client, then they will require our client to complete a judgment debtor Fact Information Sheet, Form 1.977 of the Rules of Civil Procedure. At that point, our client will be required to, under penalties of perjury, tell the creditor everything that our client owns. They will have to disclose the beneficial interest in the land trust to the judgment creditor. Even if our client forgets to list the asset on the form, they will be giving the judgment creditor the past two years of tax returns. If the property is listed one of those, they’ll find it that way. At that point, the judgment creditor would obtain a court order that seizes our client’s interest in the land trust and directs the trustee that they are now the beneficiary instead of our client. If our client is the sole beneficiary, then it’s an easy task for the judgment creditor. If there are two or more beneficiaries, then arguably, the judgment creditor will be able to obtain only a charging lien against our client’s interest in the trust. With that, if the trustee ever receives any funds that are to be distributed to our client, those proceeds would be distributed to the judgment creditor pursuant to the charging order. The judgment creditor would not gain control of the trust if there are multiple beneficiaries.

The above is all considering that the attack is from an “outside” creditor, someone whose claims do not arise from the property itself. If the attack is by an “inside” creditor (i.e. a tenant or guest who is injured on the property, or a contractor who isn’t paid for work on the property), then the land trust provides great asset protection. The trust’s asset, the property itself, is the only asset at risk in that event. In other words, if someone suffers damages related to their use or other connection with the trust property, then they would sue the trustee as land trustee of the trust only. The only asset that the land trust holds is that one property, so none of your other assets are at risk. This is also true of code enforcement liens against that property which are considered to be general liens that would normally attach to everything you own in that county where the lien is recorded. However, if the property is held in its own trust, then the lien only attaches to that property, assuming that the trustee is not the same person or entity as the beneficiary.

For an additional layer of protection and simplification of tax return preparation, most of our clients form an LLC or two in Delaware that serves as the beneficiary of all of their land trusts. They choose Delaware because the names of the members and managers are not publicized. The client often will form one LLC that elects to be taxed as an S-corporation. That LLC is used for buy-rehab-flip properties that will be held for less than 12 months since that company will likely be treated as a “dealer” by the IRS. They then have a second LLC that elects to be taxed as a sole proprietorship (if only one member) or partnership (if more than one member) for properties that they are buying to hold for more than 12 months. The Tax Code typically is kinder to buy-and-hold properties held as a sole proprietorship/partnership with pass-through taxation, and such entities provide more flexibility from a tax standpoint should the company ever need to distribute the real estate to the members directly. On the other hand, S-Corporations typically receive better tax treatment as “dealers” when it comes to real estate that is held for less than 12 months. In any event, clients never want to risk being categorized as a dealer by the IRS if they also have properties that are to be held for a long term. A CPA can explain the details of this particular tax issue if more information is needed.

As stated in the beginning, while most people convey multiple parcels of real property into their revocable living trust for estate planning and probate purposes, we recommend that they only convey one parcel of real estate into each land trust, and that an independent, non-beneficiary, and unrelated entity or person be designated as the trustee of each land trust. In this way, each parcel is in its own separate land trust, safely tucked away from the beneficiary’s name on public records, and also insulated from any other properties or other liabilities that the beneficiary owns. A Delaware LLC (or two, as tax issues may suggest) can be formed and designated as the same beneficiary of all of the client’s various land trusts, and the client’s revocable living trust can even be one of the members of the LLCs. While nothing is foolproof when it comes to asset protection, the land trust is definitely a vehicle that is effective and available to clients in Florida. When coupled with a Delaware LLC or two and a revocable living trust, it can not only provide anonymity, asset protection, and tax benefits for the client, it can also avoid probate after death.