LAND TRUSTS IN TEXAS

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 trust.

For example: Is the creator of the trust (the "trustor" or "grantor") intending to design a probate avoidance device for the homestead (often called a "living trust" or "intervivos trust")? Is the trust being created for anonymity purposes as part of an asset protection plan – possibly in combination with an LLC? Or does the trustor want to quietly acquire or dispose of investment real estate?

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.

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. 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.

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 trust, the client will need to specify which persons or entities will be acting in each role. Names should be supplied in exactly the form these persons will sign the trust documents. Note that the same person cannot serve as Trustor, Trustee, and Beneficiary – or the trust disappears as a matter of law (doctrine of merger).

There are two parts to the land trust process: (1) creating the trust; and (2) deeding the property into the trust.

The most common types of land trusts as follows (these are our terms):

A checklist of information that the attorney will need in order to begin preparing a land trust is attached at the end of this article.

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." County clerks have no problem recording a deed into the name of a trust so long as the trustor´s/grantor´s signature is acknowledged. In fact, this method is preferable since no individual names are disclosed (the trust agreement is not a recorded document). The real-world consequence of titling trust property this way is that a title company will ask to see the trust agreement before insuring a subsequent transaction. This is not a problem so long as a properly drafted trust agreement actually exists – as it should.

There are two basic types of land trusts used by real estate investors: (1) an "entry trust" (my term) 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" (my term again) 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. /p>

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.

How does this work in the context of an exit trust? 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.

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. 5.061 et 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 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.

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.

Therefore, the optimum use of a trust is in conjunction with an LLC as part of an overall asset protection plan. One scenario is this: the property is transferred out of the individual investor´s name and into the investor's LLC, which in turn deeds the property into a land trust.

Trusts combined with LLC´s can present significant hurdles to a plaintiff who wishes to find and sue the property owner. It is even more effective if the investor also sets up a separate Texas LLC to be a management company that deals with tenants and the public (i.e., the true name of the ownership LLC and the trust are never revealed). The management company is a pass-through entity that collects and disburses funds. At any given moment is essentially an empty shell with no significant assets.

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.

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. This is a crucial point for investor trusts as well (see below). 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 can defeat 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 trustor´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 internet land 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 them generate 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.