"What Is A Land Trust"
What Is a Land Trust?
A real estate land trust is just one of many varieties of trusts. A trust, in legal terms, is any arrangement in which one party holds property for another party's benefit. The property owner never gives up control of the assets — cash, stocks, bonds, real estate — but the trustee becomes the owner for legal purposes.
The function of all trusts is to shield the asset owner from certain legal proceedings and tax exposure. A wealthy couple might create a trust to shield some of their assets from estate tax when they die. In the case of real estate land trusts, the trust greatly simplifies the process of passing on the real estate to heirs or new owners. A trust can be either irrevocable — where the trust arrangement cannot be canceled — or revocable, meaning it can be dissolved at any time. There are four necessary parties to every trust agreement:
- The first is the owner of the property, called the grantor or settlor.
- Then there's the property or asset itself, known in legal parlance as the trustees or principal.
- The person or entity that holds the property is the trustee.
- Anyone who benefits from the assets in the trust is the beneficiary.
Let's use a hypothetical example of a real estate land trust. John Smith and four of his business partners own an apartment building. They decide to transfer the property into a land trust. They choose a law firm to act as the trustee. Since John and his business partners earn rental income through the apartment building, they are also the beneficiaries of the trust.
A real estate land trust that follows the "Illinois" model is a revocable trust, meaning it can be altered or canceled by the property owner at any time. On the next page, we'll list more of the benefits, and a few of the potential drawbacks, of creating a real estate land trust.
Pros and Cons of Land Trusts
To understand the legal benefits of a real estate land trust, let's continue to use the example of John Smith and his business partners, who created a land trust to hold the title to an apartment building they own in Chicago.
The first benefit of real estate land trusts is privacy. Once the title to the apartment building is transferred into a trust, the names of John and his business partners cannot be disclosed without a court order. One advantage of remaining anonymous is to avoid litigation. If people think that John is fabulously wealthy, they might dream up frivolous lawsuits against him. But if John's name is not on any public real estate records, he's less of a potential target.
Another benefit of land trusts is that multiple owners of a property aren't punished by legal judgments against only one of them. If John didn't have a land trust, and one of his business partners was sued by his creditors, then the creditor could place a lien on the title to the apartment building. That would be damaging to John and the rest of the property owners. With a trust, however, the apartment building is shielded from legal actions against one of the other owners.
Another major advantage of a real estate land trust is what lawyers call "ease of conveyance." In other words, it's easy to transfer ownership of the property to heirs without involving lawyers or courts. Usually when someone dies, their will has to be approved and their assets appraised through a costly legal process called probate. Probate can also involve payment of back taxes and debts. With a trust, the property owners create a succession plan that names new beneficiaries upon death. Since the trust itself never "dies," no probate is required.
A potential disadvantage of land trusts is the false belief that the trust protects property owners from all liability. Even in Illinois, where the modern real estate land trust was born, courts have ruled that the real property owner, not the trustee, is liable in cases dealing with the direct management of the property. It's also dangerous to think that a land trust offers bulletproof privacy. A court can order full disclosure of property ownership for any number of civil and criminal complaints. The legalities of land trusts are highly complex and differ state by state, so it's critical to obtain the counsel of a reputable trust lawyer.
Lastly, it's wrong to think that trusts don't pay taxes. The IRS requires all trusts, including land trusts to file Form 1041 [source: IRS]
Real estate land trusts are not the only kind of land trusts. On the next page we'll explain how nonprofit organizations use land trusts to promote environmental conservation and affordable housing.
Bottom Line
It's clear that not all land trusts are created equal. Real estate land trusts are designed to shield wealthy investors from litigation and taxes, and conservation and community trusts are dedicated to keeping the land healthy and housing affordable. Interestingly, it seems that real estate land trusts are almost more trouble than they're worth. According to lawyers who write on the subject, there are plenty of unscrupulous shysters trying to convince property owners to place their assets in a trust, promising legalized tax evasion for the price of a simple contract. The truth is that real estate land trusts are only legal in a handful of states, and even then are subject to close scrutiny.