Are Trusts Good for a Real Estate Investor's Asset Protection Plan?

Real estate investors seem to have an insatiable curiosity about how to protect their assets. New investors sometimes get so hung up on deciding between the many options they never get around to investing.

No doubt it is a confusing mess. There is a whole alphabet soup of entities to choose between…LLC, LP, FLP, “S” corporation, “C” corporation, trusts, general partnerships…They all sound so official and important.

You could spend many weeks researching all of the different entities, and still not arrive at the best answer. Worse yet, you do not make money as an investor figuring out how to structure your portfolio. You make money negotiating with sellers, lenders, and buyers. Every minute you spend deciding what entity to use and setting up that entity is a minute you have not spent on a money making activity.

I have a set of answers I have put together based upon 15 years as an investor, ten years as a real estate attorney, and many weeks of study of all the alternatives. I share that system which involves corporations and limited partnerships with my students in every seminar and set up clients with the entities they need a few times a week. In this article I want to share with you some of my thoughts on trusts for the real estate investor.

Land trusts are certainly a hot issue in investing. Some national speakers extol their virtues but many investors find when they return home their attorney, insurance agent, title agent, and banker poo-poo the idea of trusts. I generally dislike trusts because they complicate your investing and depending upon which trust you use either cause you to pay high taxes or provide little asset protection.

Background on Trusts.

There are two basic kinds of trusts: revocable; and non-revocable. Revocable trusts are sometimes referred to as “living trusts”, “grantor trusts”, “land trusts”, or “Massachusetts trusts.”

There are three roles to be played with both kinds of trusts – the role of trustor (sometimes “settler”), trustee, and beneficiary.

A quick description of a trust is that a trust is a legal entity where the “trustor” places property with a “trustee” who holds and administers the property for the benefit of the “beneficiary.”
The “trustor” or “settler” is the person who puts the property into trust. The “trustee” is the person who administers the trust including managing the property held in trust, filing tax returns as necessary, and record keeping. The “beneficiary” is entitled to the benefits of ownership (i.e.; the profits). Sometimes all three roles are played by one person which is the proper way to run a revocable trust.

Differences between revocable and non-revocable trusts.

The two kinds of trusts differ in their permanency, tax consequences, and asset protection.

Permanency. Revocable trusts are not necessarily permanent. The settler can “revoke” or cancel the trust by removing the property from the trust. Non-revocable trusts are permanent because the settler cannot readily remove the property from the trust. Sometimes a court order is required to remove the property from a non-rrevocable trust.

Tax Consequences. Revocable trusts do not pay separate federal taxes when the settler is the sole beneficiary and trustee. The trust income is reported on the settlor’s schedule 1040. Non-revocable trusts DO pay their own taxes. The rates vary from time to time and can be very high. Calculating the tax bill for an irrevocable trust can be complicated and the rules are found in subchapter “J” of the Internal Revenue Code in sections 641-692. Tax treatment of trusts under state law varies. In Pennsylvania some trusts are subject to the “Capital Stock Tax” which causes business trusts to pay tax on its income and assets.

Asset protection. Revocable trusts where the settlor is the trustee and beneficiary generally provide little in the way of asset protection. Revocable trusts do provide sturdy asset protection.

Benefits v. Drawbacks.

Benefits. All trusts provide some privacy (the beneficiary is generally private information known only to the trustee). Non-revocable trusts provide strong asset protection. Creditors of the beneficiary cannot take the property held in trust nor can they take the income generated by that property. If you are using a revocable trust you will not pay extra federal tax.

Drawbacks. Practical problems abound when you try to use trusts. Title companies often do not want to insure title, property and risk insurance companies will not offer property and liability insurance, and banks do not want to lend to trusts. If you use a non-revocable trust which provides good asset protection you will pay taxes twice.- first the trust will pay taxes on its income then the beneficiary will pay taxes on the income he receives. If you use a revocable trusts to avoid the taxation then you will not receive good asset protection.

When to Use Trusts.

Trusts are advisable as part of an estate plan developed by a competent attorney and accountant. Trusts are NOT advisable as vehicles to hold real estate investments. There are much better entities to use to hold real property for investment. Generally those entities will be limited liability companies (“LLC”), corporations (sometimes “S” sometimes “C”), or limited partnerships (“LP”). Those entities carry different tax burdens and tax minimization opportunities but all of them provide good asset protection, and are well understood by lenders, title companies, and insurers. In plain English it means you will have the protection you need, will not pay extra taxes, and you will be able to get the insurance and money you need to conduct your business.

I hope this article gives you a better understanding of trusts and when to use them.

Bob Diamond,
Real Estate Investor, Teacher and Attorney at Law

See more info at http://www.bobdiamond.com