Land trusts are one of the most popular vehicles in which to take title to real estate. Ask any experienced real estate investor and he probably has used this vehicle or has heard of its benefits. The main reason for using this vehicle is two-fold – Privacy and Lender Protection. However, the land trust does not provide asset protection. Hence, we recommend you use it in conjunction with a Limited Liability Company.
Privacy
First, do you want every person with a computer finding out what you are worth with a few simple key strokes? Think about it. Owning real estate in your own name is like walking around passing out your financial statement to everyone you meet. In every county in the United States, copies of real estate deeds are recorded for the public to view at their convenience.
“Due on Sale Protection”
Whether you are aware of it or not most mortgages have a little clause buried in the small print that reads in part “If all or any part of the property herein is transferred without the lender’s prior written consent, the lender may require all sums secured hereby immediately due and payable.” The legal term for this language is an “acceleration clause” i.e., Due-On-Sale clause. This clause gives your lender the option to demand full payment of your remaining loan if you sell or transfer title to your property. The key word here is option. Most people mistakenly believe that if they transfer title to property and they violate the due-on-sale clause they have committed an illegal act. This is because most people confuse criminal liability with civil liability. To be illegal the act must be in violation of state or federal criminal law. There is no federal or state law which criminalizes the violation of a mortgage due-on-sale clause. If the lender discovers that you violated your mortgage contract the lender has the Option (another way of saying the lender may call the loan due and payable if it wants to but is not required to) of calling the loan due and payable.
Why this is a concern for experienced real estate investors — asset protection. Every seasoned real estate investor knows of the multitude of liabilities that exists when it comes to investing in real estate. To protect themselves from losing everything in the event of one lawsuit they will seek the protection of a Limited Liability Company, “LLC”. The problem that arises when an investor transfers his property into a LLC is that a technical violation of the due-on-sale clause occurs. Thus, if an investor wants the asset protection afforded by LLCs, he must risk alerting the lender to the transfer and the lender exercising the due-on-sale clause. Are you caught between a potential creditor and lender? Not if you implement a land trust…
Avoiding Violation of the Due-On-Sale
Say you want to transfer title to your property to a third party or an entity for asset protection, but want to avoid alerting your lender and running the risk that the lender might exercise the due-on-sale clause. Congress has carved out some exceptions (a.k.a., protections from lenders) for you via what is referred to as the Garn St. Germain Act. The Garn St. Germain Act provides in part:
With respect to a real property loan secured by a lien on residential real property containing less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a cooperative housing corporation, or on a residential manufactured home, a lender may not exercise its option pursuant to a due-on-sale clause upon:
(1) the creation of a lien or other encumbrance subordinate to the lender’s security instrument which does not relate to a transfer of rights of occupancy in the property;
(2) the creation of a purchase money security interest for household appliances;
(3) a transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety;
(4) the granting of a leasehold interest of three years or less not containing an option to purchase;
(5) a transfer to a relative resulting from the death of a borrower;
(6) a transfer where the spouse or children of the borrower become an owner of the property;
(7) a transfer resulting from a decree of a dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement, by which the spouse of the borrower becomes an owner of the property;
(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; or
(9) any other transfer or disposition described in regulations prescribed by the Federal Home Loan Bank Board.
It is a contractual right, not a law. This means that if title to the property is transferred, the bank may (or may not), at its option, decide to “call the loan due.”
Solution
To combat these perceived challenges to real estate ownership, many experienced real estate investors have turned to a land trust to find solace. A land trust is an inter-vivos trust; hence, it is protected under the Garn St. Germain Act. In fact, the land trust is very similar to a living trust but only slightly modified to achieve different results.
A land trust, like a living trust, has four components:
1) Grantor – the person who establishes the trust;
2) Trustee – the person or entity that holds the trust property for the benefit of the trust beneficiaries. The trustee holds title for the benefit of the grantor (in this case, the grantor is also the “beneficiary”). If you place title to your property into a land trust, you have not violated the due-on-sale (so long as there is no change in occupancy);
3) Beneficiary – the person or entity that receives the benefit of the trust property;
4) Trust Assets – the property that is deeded into the name of the trust.
The experienced investor who wishes to avoid the due-on-sale clause will establish a land trust, then nominate someone other than himself to serve as the trustee (This is referred to as a nominee trustee. In a land trust the trustee has little to no power over the trust. The trust is controlled by the beneficiaries with the trustee merely serving as a figure head), deed his property into the name of the trust (When deeding property into a trust you deed into the name of the trustee care of the trust, e.g., John Doe as Trustee of the 4th Street Trust Dated January 1, 2005), have the Trustee resign and appoint himself as the trustee (The change in trustee does not get recorded thus, from a public record standpoint, your nominee trustee still appears as the current trustee of your trust), and finally assign the beneficial interest to an entity such as a Limited Liability Company for asset protection.
