In a previous post, I discussed the use of an LLC to protect your real estate investment. Another layer of protection that you can use is a Land Trust.
What is a Land Trust?
A land trust is essentially a contract that holds title to a property. It consists of three parties:
The grantor is essentially you the owner (or buyer) of the property.
The trustee is the contact person for the trust, similar to a registered agent for a corporation. The major difference is that the registered agent of a corporation is required to be located in the state where the corporation is set up. The trustee can be anywhere and does not require a physical address. The trustee can use a post office box number (registered in his or her name) for contact purposes.
The trustee provides an additional layer of anonymity.
The beneficiary is the ultimate beneficial owner of the trust. Under any type of trust, in case anything happens to you as the owner (grantor) of the Trust, the beneficiary of the trust will essentially inherit your interest in the trust without going through probate.
The beneficiary can be an individual (not advisable), an LLC, or a corporation.
The beauty of a land trust is that it is a non-recordable document. That means that it does not have to be registered with the state. Therefore, if the title to the property is held by a land trust, there is no way to find out who the beneficial owner is.
Changes can be made to the land trust without those changes becoming part of the public record. I will discuss how this can be useful later.
How Many Properties Can You Have In a Land Trust?
The simple answer is that you can have as many as you want. However, if you were to put all your investment properties in one land trust, and one property were to be sued, all the other properties in the land trust would also be at risk.
For maximum protection, each property should have its own separate land trust with a corresponding LLC as the beneficiary. If you want to save some time and administrative costs, you could have one beneficiary for all the separate land trusts.
In the event that one property is sued, you could set up a new LLC and change the beneficiary of the remaining land trusts to the new LLC. Since it is a non-recordable document, no one would be aware of this change.
TIP: When setting up the land trust and the corresponding LLC, it is advisable that they have the same name. Using part of the property address in the name is useful in keeping track of your holdings, and will help to simplify the deal when you choose to sell the property.
Purchasing Property Using a Land Trust
As many of you are already aware, it is difficult to purchase a property through an LLC if you need mortgage financing. This is particularly true if you are a novice investor.
The simplest method is to purchase the property personally and qualify for the mortgage using your personal financial information. This provides you with no legal protection or any tax benefits.
Some investors will then transfer ownership of the property to an LLC after the deal has closed. However, doing so runs the risk of triggering the “due on sale” clause in the mortgage agreement. The lender could potentially call the mortgage due and payable.
Beating the Due on Sale Clause
In 1982, Congress passed the Garn-St. Germain Depository Institutions Act. This law provided a number of carve-outs that prohibited the banks from invoking the “due on sale” clause. You can read more about those provisions here.
The provision we are interested in is transferring title to a land trust. The lender cannot call the mortgage when you set up this trust.
However, some lenders will have an additional clause whereby they can levy a fee if the ownership of the property is transferred. This can be as much as 1% of the mortgage value. Be careful to review your loan documents before signing to avoid this potential cost.
Common Mistakes When Setting Up a Land Trust
1) Serving as Your Own Trustee
Although you can do this, it totally defeats the purpose of the land trust. You do not want your name associated with the ownership of the property in any form.
Ideally, you want a trustee that lives out of state (or out of the country) that can only be reached via a post office box that is registered in his or her name. This makes it extremely difficult for an attorney to serve a lawsuit.
I should also point out that you do not want to be the trustee and the beneficiary. In the event of a lawsuit, the court could rule that the land trust served no purpose since the grantor (you) and the beneficiary (you) are the same.
2) Using Your Home Address
Do not use your home address for receipt of correspondence or bills. If an attorney is searching for the beneficial owner of the land trust and discovers that the mailing address is your home address, it will be logical to conclude that you are somehow involved with the land trust. All correspondence should go to your trustee.
3) Failure to Assign Interest
Some investors will set up the land trust but fail to set up an LLC as the beneficiary. In the event, you are sued personally and you are the beneficiary of the land trust, you could lose your interest in the land trust.
Make sure that you set up the LLC in a state where your LLC is protected from charging orders. I discussed this in my previous post.
4) Informing Your Lender of the Change in Ownership
As discussed previously, transferring ownership to a land trust does not invoke the “due on sale” clause. However, some investors think they should notify the lender as a courtesy. This can only create confusion and generate problems for you.
5) Using the Term “Land Trust” in the Name of Your Land Trust
Land trusts are only recognized by statute in some states. If you are setting up a trust in a state that does not recognize land trusts by statute, naming your trust as, for example, ABC Land Trust, you will only create confusion and potential problems. Only use the word “Trust” in the name. If a lender or anyone else asks you what kind of trust it is, refer to it as a “Grantor Trust”.
There are many types of trusts; some are much more common than others. So by using just the word, “Trust” usually goes without notice.
The Bottom Line
Land trusts are a valuable legal tool to hide your identity and provide additional protection for your real estate investments. It is important that the legal entities be set up properly and in the proper order. As such, you should retain the services of a seasoned corporate real estate attorney. Do not attempt to do this on your own.
The information provided here is for educational purposes only and is not to be construed as professional legal, tax, or financial advice. Every situation is unique and you should consult with an attorney, tax accountant, or financial adviser to determine the best options for your personal situation.