In my real estate law practice, clients often ask about land trusts and how to use them in Ohio. The truth is that in my opinion these structures needlessly complicate an investor’s deal structure and don’t provide any benefits that aren’t already available with an Ohio LLC. They’re often pushed by ‘strategists’ who don’t have law licenses in Ohio or any other state–and they’re selling document packages for exorbitant prices that we often end up having to undo anyway. To begin, let’s look at what a land trust is, and understand the promised benefits before we dive in and talk about the pitfalls and the easier ways to accomplish it.
What is a land trust?
In a nutshell, a trust is a basically a contractual arrangement between the person creating the trust (‘settlor’ or ‘grantor’) and a trustee to manage or give property to beneficiaries. A land trust is, for lack of a better description, a trust that only holds land by its terms.
Land trusts are specifically recognized by the law of Illinois (and probably a few other states), and are popular there. In that state, specific requirements apply for holding land in a land trust in Illinois. Importantly, Ohio does not have the same rules about land trusts. In Ohio, a land trust is just a garden-variety trust with no special advantages over a trust that you would create for estate planning. Also in Ohio, a trust is not able to hold property–it must be held by the trustee, although reference to the trust may be made.
A trust comes in two basic varieties: revocable and irrevocable.
Like the name implies, the grantor of the revocable trust can revoke the trust at any time, fire the trustee, and get the property back. A plan like this is great for estate planning because it gives flexibility, but importantly, it gives no creditor protection. In a bankruptcy court, creditors can force the grantor to revoke the trust and sell the property to the creditors.
An irrevocable trust is more permanent: once the trust is created, the grantor can’t get the property back or fire the trustee. This is a more valuable asset protection strategy because it protects the assets from creditors who can’t force the grantor to revoke the trust. The unfortunate drawback to this arrangement is that a third-party trustee must be used and the grantor loses control over the property.
Privacy with a land trust?
Most commonly, the land trust is pitched as a vehicle for privacy. It is said that if you place the property in a land trust, no one will be able to identify you as the owner of the property. This is indeed true if the grantor appoints another person as the trustee of the trust and that person is in fact willing to manage the property on the grantor’s behalf.
There are easier ways to achieve privacy
As I mentioned in the introduction, this is a complicated strategy that perhaps works in a few states, but is of little value in Ohio. Simply forming an LLC and designating a third party, like your attorney, as the ‘authorized representative’ on the articles of organization keeps your name off the public record as the owner of that LLC. No need for a trust for this.
Avoiding the due-on-sale clause
Most mortgages contain a ‘due-on-sale’ clause which places the borrower in default if they sell or transfer the property. A contribution to of the property to an LLC can technically trigger this clause. Hence, many investors, concerned with the due-on-sale clause, have taken the advice of unscrupulous trust-salesmen who tell us that the lender are prohibited by federal law from triggering the due-on-sale clause. Somehow, they insist, the land trust can be used as a vehicle to obtain limited liability, privacy, and avoid the due-on-sale clause. Below I will discuss why that is not ultimately possible.
Garn-St. Germain Act: the due-on-sale approval law
The federal law they reference is called the Garn-St. Germain Act of 1982. This statute actually was intended to prevent state courts from striking down due-on-sale clauses as unconscionable. As interest rates hit 18% in the early 80s, it was common practice for a buyer to assume the low-interest-rate mortgage of the buyer. Banks would frequently attempt to foreclose in order to force the buyer to refinance at the higher rate, but courts refused to enforce the due-on-sale clause, reasoning that the bank is in no worse position just because the borrower’s identity changed. Congress took action by overriding state law and blessing the due-on-sale clause, carving out specific exceptions that cannot trigger a due-on-sale clause:
- a subordinate lien or second mortgage;
- a lien for household appliances;
- a transfer by inheritance;
- a lease of less than three years;
- a transfer by virtue of the death of the borrower;
- a transfer to spouse or children;
- a transfer as a result of divorce;
- a transfer into an inter vivos trust in which the borrower is and remains beneficiary and which does not relate to a transfer of rights of occupancy in the property;
- any other transfer or disposition in regulations prescribed by the Federal Home Loan Bank Board.
Exception number 8 is the bedrock upon which the land trust strategy rests. The Importantly, however, the borrower must remain the beneficiary. In the trust business, we call this a self-settled trust, which is not an ideal asset protection strategy as discussed below. Secondly, who is the trustee supposed to be? Will it protect my interests? We’ll also discuss that below.
The self-settled trust and bankruptcy
Section 548(e) of the Bankruptcy Code addresses the self-settled trust head-on. In a nutshell, a bankruptcy court may disregard a self-settled trust created less than 10 years ago if they find any reason to believe that the transfer was made with intent to hinder creditors — a low bar. This even applies to the new Asset Protection Trusts created by the laws of several states — states whose laws are unfortunately subordinate to the Bankruptcy Code. So if you’re being threatened personally by creditors, those creditors have the ability to undo the trust and force you to sell the property — something that would not happen if you held the property in an LLC in a state with strong LLC laws protecting against creditors, like Ohio.
Who is supposed to be the trustee?
This is a great question to ask the asset protection salesman. The potential answers are as follows:
- An LLC you form
This option is the most common suggestion, but it’s fraught with pitfalls. An LLC may be considered a trust business under Ohio law, which requires trust companies (like banks) to obtain a license if they are going to engage in trust business. The law specifically excepts natural persons from having to obtain a license, which leads to suggestion number two, yourself.
If you’re both the grantor, trustee, and beneficiary, you’ve just created the basic foundation of an estate plan, but you provide yourself no asset protection at all. Some proponents of the trust strategy say that you should designate the LLC as the beneficiary, but this leads to two specific problems: first, this structure violates Garn-St. Germain, and second, it protects no assets. The LLC is not the trustee in charge of the property and therefore won’t be the proper party to sue if liability arises. The LLC will only be entitled to the cashflow of the property as the beneficiary of the trust, which won’t affect what the plaintiff in a lawsuit can recover from you, the trustee of the trust. The law is clear on this arrangement also: if the grantor of the trust is also the trustee, creditors can reach the trustee’s assets.
3. A third party
This is perhaps the most effective arrangement, but it has two major problems: first, you lose control of the property, and second, it is still a self-settled trust where the grantor is also the beneficiary, which as we discussed above can run afoul of the bankruptcy code. Additionally, this is fraught with peril for your friend, the trustee, who will be sued personally if liability arises from his or her management of the property.
What to do?
I think many legal practitioners are hesitant to tell clients to simply violate the due-on-sale clause, even with a discussion of the risks. Bar associations across the country are not hesitant to revoke law licenses for absolutely innocuous reasons, siding with disgruntled clients who came to the lawyer in the first place asking how they can get around the law. I’m no different in this respect, but I urge you to do your own research on how often the due-on-sale clause is enforced when a borrower contributes the property to a single-member LLC. The beauty of this transaction is that it provides well-recognized limited liability protection, and is easily revocable if the bank objects to it. A willful lender may not be prohibited from throwing the book at the offending borrower even after the transaction is undone. From a practical standpoint, however, a lender would be unwise to do this in today’s low interest rate environment. The truth is that most banks are concerned about cashflow more than technicality. As always, be aware of the risks. The due-on-sale clause is part of the contract you signed, and there is no easy solution for avoiding it.