 
DAVID J. WILLIS ATTORNEY
http://LoneStarLandLaw.com Copyright © 2010. All rights reserved
TRUSTS IN TEXAS by David J. Willis Attorney PART ONE: AN OVERVIEW OF TRUSTS Introduction There are many kind of trusts that can hold real estate as an asset (ie., as part of the “trust estate”). There are four basic goals in trust formation:
In choosing a type of trust, one needs to be clear about what one is trying to accomplish. For purposes of the scope of this article, the following are the main types:
Is the trust being created for anonymity purposes as part of an asset protection plan? Does the trustor want to acquire or dispose of investment real estate? Or is the objective more focused on estate planning? Perhaps the trustor wishes to achieve a combination of these objectives. "Standard" Trusts Clients often request 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. Note that maximum asset protection is achieved when a land trust is used in combination with a limited liability company. Trusts vs. LLC's 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 is still exposed. Note on Holding Title The textbook-correct way to hold trust property is in the name of the trustee - for example, “John Jones, Trustee of the ABC Trust.” However, there is no violation of existing law nor is there any penalty associated with simply conveying property into the “ABC Trust.” County Clerks accept such deeds for recording. They are valid conveyances. However, by deviating slightly from the accepted practice of naming the trustee in the deed, an additional measure of anonymity is achieved. The consequences? Few. If one desires to re-finance the property, the lender may require that title be changed. Also, if the property is later sold through a title company, the title company will want to see a copy of the trust agreement before issuing title insurance on the transaction. No problem. Trusts in Conjunction with an LLC The optimum use of a trust is in conjunction with an LLC as part of an overall asset protection plan. There are a variety of potential scenarios:
Principles of Asset Protection Asset protection, whether achieved by establishing an LLC, a trust, or a combination of these devices, consists of two basic principles:
The more “fences” an opponent and his attorney must jump in order to get to you and your assets, the better. The basic asset protection plan in Texas is the following:
The New Texas Series LLC The new Texas series LLC, which allows assets and liabilities to be held in insulated compartments or “series,” is now the preferred vehicle for real estate investors. It was created by the 81st legislature in 2009. Investors previously had to go to Delaware to obtain such a vehicle, but no longer. The Texas series LLC should be at the core of your asset protection plan. In the traditional LLC, all assets of the company are potentially liable in the event the company is sued or a judgment is obtained. The series LLC prevents this by establishing series in which properties or businesses are held separately and distinctly from the assets held by other series. In other words, Series A could contain a rental fourplex; Series B could contain a strip center; Series C could contain a business that buys and sells real estate notes; series D could contain a general contracting business; and so on. All these enterprises can be contained within the same company while maintaining the insulation of each asset from the liabilities associated with other assets. For example, suppose there was foreclosure on the property contained in Series B, and there was a deficiency at the foreclosure sale (ie., the property sold for less than the amount owed). The lender then sued and obtained a deficiency judgment. Assuming that the company and its transactions were properly constructed, the judgment would be enforceable only against Series B assets - not against the assets of any other series. The assets of the other series would not be available to satisfy that judgment. It is no longer necessary to ask, "How many LLC's do I need for my various properties and businesses?" In most cases, the answer is now "Only one." This represents a substantial in economy and simplicity. For more detail on the Texas series LLC, see our companion article on this site. The Living Trust The living trust or “intervivos trust” is recommended as the best way to hold title to the Texas homestead. It 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 as part any middle-class estate plan. See Part Two of this article for details. The Anonymity Trust 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. As discussed above, the deed should simply name the trust. Note that trust agreements are not recorded documents. The Entry Trust (Transfer to a Trust Followed by an Assignment of Beneficial Interest) 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 (this is sometimes referred to as an "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. 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 Asubject 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. The Exit Trust (Transfer to a Trust Pending Credit Repair by a Buyer) In this case, the trustor/investor is the seller. Property is conveyed into a land trust that acts as a temporary Aparking place for the property while a credit-impaired buyer (a trust beneficiary) 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 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. Ideally, the trustor/investor first conveys the property into his series LLC, which is the entity designated by the investor as being the "ownership entity" in his or her asset protection plan. This is followed by a transfer from the series 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. At closing, the trustee conveys all powers to an Attorney-in-Fact/Managing Agent which should be a shell management company designated by the investor to conduct day-to-day operations, including all dealings with tenants and the public. It may also be a good idea for the management company to do business under a "dba" - an assumed name. 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 ultimate buyer) who receives the trust's consent to occupy the property and 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 on monthly payments. The trust agreement is the core document that sets forth the duties and obligations of the parties. It is a detailed and sophisticated document that has evolved as a result of creating over a hundred land trusts and undergoing judicial scrutiny on numerous occasions. Even with all the information in this article, it cannot be duplicated by a beginner. There 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. The only deed being executed is the deed into the trust. The Role of the Title Company 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. Otherwise, the title company may 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. No internet service will do this. Beware of Internet Trusts 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 lease-options. Some attempt to create liens that are unenforceable in Texas. Few of them consider using an LLC in tandem with the trust, an essential element in achieving asset protection. All of them generate complicated transactional documentation with Afill-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 real estate lawyer who knows what he is doing in this area. The Land Trust as an Alternative to Lease-Options A well-drafted land trust provides an alternative to lease-option transactions, the traditional investor favorite, but which are now largely unworkable in Texas because they are now defined to be executory contracts under Sec. 5.062 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. Section 2(a) 2 of the Code states: An option to purchase real property that includes or is combined or executed concurrently with a residential lease agreement, together with the lease, is considered an executory contract for conveyance of real property.
The effect is to place residential lease-options under the same burdens that apply to contracts for deed, which most investors have now abandoned. Although there is an exception for lease-options for six months or less, this is not usually a sufficient period of time to accomplish investor objectives; and tacking six-month lease-options together is not likely to fool a judge. We argue that the land trust 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. Comments on Due-on-Sale Clauses It is widely advertised that land trusts legally prevent a lender from exercising a due-on-sale clause. Is this true? No, it is not, although acceleration may be much less likely. The explanation for this is somewhat technical. 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. Note that there is no such thing as Abreaching@ or Aviolating@ a due-on-sale clause. This is an enabling clause that gives the lender the option of acceleration if the lender chooses to do so. Look carefully at paragraph 18 of the Fannie Mae/Freddie Mac Uniform Deed of Trust and you will see that this is true. Living trusts receive direct protection from due-on-sale provided by the Garn-St. Germain Depository Institutions Act (U.S.C. Title 12, Chapter 13, Sec. 1701j-(d) reads: . . . a lender may not exercise its option [to accelerate the note] pursuant to a due-on-sale clause upon . . . (8) a transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property. 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 Investor trusts do not receive similar protection, since the federal exception is limited to properties that are owner-occupied; but the reality is that in the current marketplace this usually does not matter. Lenders, having their plates full with notes in monetary default, are not generally inclined to accelerate otherwise performing loans, even if they know that the property has been transferred to an investor trust. 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.Seven-Day Notice Requirement The seven-day notice requirement was passed in 2007 as HB 2207, now Property Code Sec. 5.016. It is a peculiar law in many respects. When a property transfer does not result in paying off the lienholder(s), the following is required: (1) the seller must give 7 days notice to the buyer before closing that an existing loan is in place; (2) the buyer is allowed this same 7 day period in which to rescind the contract to purchase; and (3) the 7 day notice must also be sent to the lender, theoretically giving the lender an opportunity to accelerate and call its note due. Actual lender consent, however, is not required. It is unclear if lenders will now use this notice as a basis for declaring loans due. So far, it is not happening. Some investors use the strategy of sending the notice to the servicing agent's payment address, which is not typically set up to receive correspondence. The notice then gets lost in the shuffle. If the notice is not given, the buyer can back out of the transaction before closing. Otherwise, there is no penalty for not complying with Sec. 5.016. Caution, however: The mortgage loan fraud law passed in 2007 as HB 176 is comprehensive. Failure to give the 7 day notice could, in conjunction with other factors, be viewed as fraudulent by a suspicious judge or jury. So it should be done. PART TWO: THE LIVING TRUST IN DETAIL The living trust (also called an "intervivos trust"), which is a specific kind of trust designed to hold property (primarily real estate) during the life of the trustor in order to avoid probate and reduce estate/inheritance taxes at the time of the trustor's death. A transfer into a trust also has anonymity benefits that contribute to asset protection, since recorded title to property can be held in the name of the trust. Creating the TrustThe person creating the trust is called the "trustor" or "grantor." This is the person who conveys property into the trust. A trustee is appointed who directs trust affairs on behalf of the primary beneficiaries (usually the trustor and spouse) and, upon the death of the last primary beneficiary, on behalf of one or more remainder beneficiaries (usually the trustor's children). Since title remains in the trust as these various persons die, the surviving remainder beneficiaries "inherit" the trust property upon the death of the last surviving parent - but without probate or other involvement by courts or lawyers. The document that creates the trust is called a trust agreement or declaration of trust. It should state the trust's purpose along the following lines: "to hold, preserve, maintain, and distribute the Trust Property for the benefit of the Beneficiaries, including but not limited to payment of expenses for their respective health, education, maintenance, and support as the Trustee, acting in his or her sole discretion, deems reasonable, prudent, and necessary." Statutory authority for creating trusts is contained in the Texas Trust Code, which is contained in Chapter 101of the Property Code. The trust agreement may expand upon or limit these statutory provisions. The trustee is charged with management of the trust and has the authority to act on its behalf. Texas law confers wide powers upon the trustee - including selling and purchasing trust property. Usually, the trustee is same person as the trustor. It is possible to name co-trustees (eg., husband and wife) and this is recommended to provide for a smooth succession in the event one spouse dies. Even if co-trustees are named, a successor trustee should also be designated in the event the last trustee becomes unable or unwilling to serve. The trustor 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 trust becomes irrevocable and the remainder beneficiaries automatically succeed to the trustor's interest. No deed or probate is required at that time. This results in an enormous saving of time, effort, attorney's fees, and court costs. Trust PropertyTrust property may include any type of property, whether personal or real, tangible or intangible. Additional property may be transferred into the trust at a later date, after the trust is established. The trust need not assume existing liabilities on trust property in order for the transfer to be effective. Property can be taken "subject to" existing indebtedness (ie., without the trustee taking any liability for the debt), or such indebtedness can be "wrapped." Real property is conveyed into the trust by general or special warranty deed (but never by quitclaim), which is recorded in the county real property records. The trust agreement, however, should not be recorded. It is a private and confidential document. Its terms need not even be disclosed to the remainder beneficiaries. A "spendthrift clause" should be included that prohibits a beneficiary from assigning his or her interest in the trust to creditors. Note that transferring property into trust does not reduce a trustor's assets for Medicaid purposes. Trust property is still counted by Medicaid as belonging to the trustor. Homestead The Trust Agreement should contain language that preserves (1) homestead protections available to Trustor pursuant to Art. XVI, Sec. 50 of the Texas Constitution and Texas Property Code Chapters 41 and 42; and (2) any homestead tax exemption currently on file for Trustor. It is prudent to make these recitals even though the 81st Legislature in 2009 added Property Code Sec. 41.0021 stating that transfer of a residence into a "qualifying trust" retains the homestead character of the property. Federal Income Taxes Since a living trust is a revocable and amendable instrument, it is recommended that one not procure a tax identification number for the trust or attempt to file separate trust tax returns (This is more often done for irrevocable trusts). Forming the trust should not affect how the trustor currently files a federal income tax return; however, this firm does not give tax advice. Consult your tax advisor to determine what is best for your specific circumstances. Generally, a client is best served if he consults both a capable attorney and a good C.P.A. Pour-Over Will It is good practice for the trustor to execute a last will and testament that contains "pour over" provisions designed to convey into the trust any property that was not previously designated as trust property. In this way, the trust and the will work together as part of an overall estate plan. It is also possible to have life insurance paid to the trust. Comments on the "AB Trust" This article focuses on the benefits available from a basic living trust, which is designed to avoid probate and achieve a measure of anonymity. There is a more complicated version, called an "AB trust," which sought protection from the federal estate tax under the old tax regime. However, the federal estate tax is currently being phased out, and there will be no estate tax in 2010 - so AB trusts are not as useful as they once were. However, the estate tax will return in 2011 unless Congress acts to extend current law. For the information of the reader, this is how AB trusts are structured: when one spouse dies, the trust is divided into two separate trusts. This is done in lieu of leaving property outright to the surviving spouse. When this is done, the surviving spouse has the use and enjoyment of the property for life (subject to certain limitations) but does not technically own it and generally cannot sell or transfer it. The result is that federal estate tax is avoided - ie., the property is taxed only once on its way to the children. The drawback is that the surviving spouse has only limited rights to the trust property. Therefore the AB trust may not be suitable for younger couples (say, under 60) who may want to retain all property rights. Using an Attorney to Draft and Maintain the Trust There is no substitute for the analysis and advice of a competent professional in this complex area of the law, especially when it comes to making the trust effective in a state like Texas where there are unique and specific laws relating to homestead property. The challenge for the attorney is to discover what the client is trying to achieve and then tailor a document to suit specific needs. That does not mean that the client must pay high legal fees. Effective, customized trusts are available from this office beginning at $550. The warranty deed into the trust is not included - the fee for a deed is $175 plus the per-page recording fees charged by the county clerk (usually $28). Simple wills in conjunction with the trust are half the usual fee. All fees are subject to change. It is also useful to have an attorney to assist with changes in trust property or amendments to trust provisions that may occur over the years after the trust is established. Trust maintenance over the years can be as important as trust formation. Attached to this article is a checklist that provides the attorney with necessary basic information to begin drafting the trust. DISCLAIMER
Information in this article is proved for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. No attorney-client relationship is created by the offering of this article. This firm does not represent you unless and until it is expressly retained in writing to do so. 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. Copyright © 2010 by David J. Willis. All rights reserved. Mr. 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. DAVID J. WILLIS ATTORNEY LoneStarLandLaw@aol.com
CHECKLIST FOR PREPARATION
OF LIVING TRUSTS Information for Document Preparation __________________________________ Complete this checklist and send it to the attorney for preparation of the trust. It is suggested that you first read our article Living Trusts in Texas which can be found at www.LoneStarLandLaw.com. Much customization is possible in drafting these trusts, so try to be specific about your instructions. There is a space for filling in any special requirements you may have. Please use email as much as possible to avoid phone tag. The address is LoneStarLandLaw@aol.com. Fees and Costs: Legal fees of $550 must be paid in advance. Online payment can be made at the website under the "Contact Us" button. Checks should be made payable to David Willis. If you wish to convey property into the trust, please email a copy of the existing warranty deed or fax it to (832) 201-5321. The fee for deed preparation is $175 plus the county clerk’s per page recording fees (usually $28). 1. What is your purpose in creating this trust? ______ probate avoidance/estate planning
______ asset protection through anonymity ______ other (explain):___________________________________________________ 2. What is the name and mailing address of the trustor (the name of the person or persons who will be conveying the property into trust)? Normally this is/are the name(s) in which the property is currently held, according to the existing deed. Name: _______________________________________________________________________ Name: _______________________________________________________________________ Mailing Address: _______________________________________________________________ Phone: ______________________________________________________________________ Email: ______________________________________________________________________ 3. If the trustor is married, but the property to be put in trust is currently titled only in the trustor's name, then what is the name of the trustor's spouse? __________________________________________________________________________ 4. What is the street address of the property to be put in trust? __________________________________________________________________________ 5. What will be the name of the trust? For anonymity purposes we suggest some variation on the address - eg., "The 123 Oak Street Family Trust." __________________________________________________________________________ 6. What is the name of the trustee (ie., the person who will manage the trust)? If there are going to be co-trustees, then list both names as they should appear on the trust document. Name: _______________________________________________________________________ Address: _____________________________________________________________________ Name: _______________________________________________________________________ Address: _____________________________________________________________________ If there are co-trustees, then: ______ either trustee may act alone on behalf of the trust.
______ both signatures will be required. 7. Who is the successor trustee? This is the person will serve if the trustee is deceased, disabled, or declines to continue to serve. Name: _______________________________________________________________________ Address: _____________________________________________________________________ 8. Who are the "primary beneficiaries?" Usually these are listed as the trustor and spouse or the survivor thereof. ______ trustor only ______ trustor and spouse. Spouse's name is: ______________________________________ ______ other: Name: _______________________________________________________________________
Address: _____________________________________________________________________ Name: _______________________________________________________________________ Address: _____________________________________________________________________ 9. Who are the "remainder beneficiaries?" Usually these are the trustor's children. Name: _______________________________________________________________________ Address: _____________________________________________________________________ Name: _______________________________________________________________________ Address: _____________________________________________________________________ Name: _______________________________________________________________________ Address: _____________________________________________________________________ 10. Special Provisions (anything else the attorney should know?): ____________________________________________________________________________ ____________________________________________________________________________ 11. Do you have a last will and testament or do you intend to create one? An estate plan is not complete without a will. Name of person completing this checklist:
_______________________________________________ Phone: __________________ Fax: ___________________ Email: _________________________________________ These instructions may be emailed to LoneStarLandLaw@aol.com or faxed to (832) 201-5321. |