Many small real estate owners (1-4 unit properties) are confused about the best entity to hold their real estate, with potentially disastrous consequences.
In fact, the majority of small property owners still own their properties in their personal names.
Perhaps they read a book or take a course on asset protection. They become aware of the disastrous consequences that can befall property owners who own property in their personal names.
All it takes is a couple of mouse clicks in the age of the Internet to get a complete listing of every property owned by you in the entire county! You can lose everything you own, not just the real estate, to judgment creditors, lawsuits, liens, the IRS, etc.
It is a proven fact, that those who can be shown to own property are at a far higher risk of being sued than those who do not own property.
Then they have to decide. Should they use a corporation to hold their property, a C corp. or an S corp? How about an LLC or a partnership?
There are serious downsides to using the wrong or inappropriate entity.
• Double taxation on income and gains with a C corp.
• Corporate taxes are levied on property sold by an S corp.
• Ownership and allocation of profits is sharply restricted in an S corp
• The corporation itself (shares) can be seized by creditors along with any real estate it owns
• LLC’s can provide liability protection, but only to business, not personal property
• Neither corporations nor LLC’s provide secrecy of ownership
• The extra cost and complexity of setting up, reporting taxes and maintaining the entity
• Partnerships can expose partner’s assets to unlimited liability
Compounding the problem is the fact that banks will generally not OK the purchase of a 1-4 family property by any entity, even a limited partnership.
There is also a prohibition, the due on sale clause; that allows the bank to foreclose on the mortgage on a property that is transferred from the personal name of the borrower to an entity.
There could also be a problem if the owner wanted to do a 1031, tax-free exchange, if the title was transferred from the original owner.
The solution is for the real estate investor to set up a land trust.
• A land trust provides total secrecy of ownership.
• It provides asset protection.
• It carries no tax implications, it is a pass through entity, meaning that any gains or losses pass through to the owner’s personal tax return.
• Although most banks will not grant a mortgage to a property in a land trust, the due on sale clause cannot be invoked against the transfer of title to a properly constructed land trust.
• It does not impair the ability to do a 1031 tax free exchange
• It eliminates the need for probate upon the owner’s death
What is a land trust? It is simply a revocable contract between two or more parties. It has been in use for centuries.
The first party is the owner of the property; the grantor, in trust speak. He grants, or transfers title to the property to the trustee. He then becomes the beneficiary, along with any co-owners. Beneficiaries of the trust retain management, control and the right to receive profits from the property
The trustee is often a non-profit corporation. The trustee’s only job is to hold title to property for owners. He is prevented by law from divulging the identity of the beneficiaries (the true owners).
He is also prevented by law from doing anything with the property that is not authorized in writing by the beneficiaries.
The beneficiaries can revoke or cancel the trust agreement whenever they want, which is not a taxable event.
Although the land trust is revocable, in other words a living trust, it should not be confused with a simple living trust, set up for probate avoiding purposes, as it often is, even by attorneys.
The land trust can provide asset protection in two ways. Number one, it provides secrecy of ownership, which may be all that is required to dissuade potential litigants, as it makes their ownership invisible.
Secondly, if the trustee is a corporation in another state, a sophisticated move; any potential litigant is faced with the prospect of suing an out of state, professional corporation. They must win their case if they are to legally force the trustee to reveal the identity of the beneficiaries. This prospect will discourage all but the most aggressive plaintiffs.
For maximum asset protection, the beneficiaries should set up an LLC to hold the beneficiary interests. Sort of like wearing suspenders with a belt.
No attorney is not needed to set up a land trust, but you have to make sure you are using a person or company with experience in setting them up, or you may not get what you pay for!