| LAND TRUSTS IN TEXAS
July 8, 1999
Dallas, Texas
Please email me at texaslaw@email.com for an updated version of this article (1/7/2004).
This article is designed to provide accurate and authoritative information in regard to the subject matter covered. It is made available with the understanding that the author is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. (From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations.)
All rights are reserved. No part of this article may be reproduced, in any form or by any means, without permission in writing from the author.
Special thanks to William Bronchick, Esq., for his permission to quote portions of "Your Step-by-Step Guide to Land Trusts", published by Flamingo Press (1-800-655-3632).
INTRODUCTION
Very few Texas lawyers have been involved in transactions which have used a land trust as an ownership vehicle for real estate. Lawyers generally prefer to avoid the use of any device that they do not fully understand. After all, the client may have expectations that the lawyer is supposed to have the answers.
Sometimes what is at the heart of a problem also provides an opportunity. The fact that land trusts are not widely utilized in Texas, that the law is not well developed in the area, and that land trusts are not fully understood by lawyers, accountants, title companies, lenders and brokers, creates both a problem and an opportunity. This paper will review the advantages and potential problems of using a land trust to obtain the benefits of real property in Texas.
HISTORY OF LAND TRUSTS
Trusts have been around for a long time. They were utilized in feudal times to convey property to a trustee to hold for the benefit of third parties, such as the church, which could not legally own property in its own right.
Since ownership of land obligated the owner to pay taxes to the King, and to serve in the King's army, legal title was sometimes transferred to relatives and friends to remove their names from the public ownership records. The former owner retained all of the benefits of ownership without having title in his name. The trustee to whom legal title was transferred dealt with the public as if he were the true owner. Only the trustee in whose name the property was legally titled and the true beneficial owner knew of the arrangement.2
The original "Statute of Uses"3 outlawed the use of trusts by declaring that such arrangements vested all title in the real estate in the cestui que trust ("he for whose use land is held by another"). The English courts modified this rule by stating that a trust was valid so long as the trustee had some duties to perform and was not a mere "nominee" title-holder.4
MODERN USE OF LAND TRUSTS
Because this form of trust originated under the common law of Illinois, and because of its use in that state5, the land trust is frequently called an "Illinois land trust." Legislation in several states, notably Alabama, Florida, Georgia, Hawaii, Indiana, North Dakota, Ohio and Virginia6, has been enacted to recognize and validate the use of these trusts.
In his survey of the issue in 1973, Richard Sayles found no known case law supporting the validity of the concept of a land trust in Texas.7 But with increasing frequency, entrepreneurs and investors have heard of the benefits of using a land trust in other jurisdictions, and Texas lawyers are being asked to opine as to the viability of such transactions. This type of trust is becoming a common means of ownership in Texas.8 It has been used countless times without any adverse consequences.9 In 1983 a new Texas Trust Code was passed, but the legal requirements for a land trust are still a little hazy in Texas.10
THE BASICS OF LAND TRUSTS
A typical Illinois land trust is usually created by two separate written instruments: (1) a deed which transfers legal and equitable title to the real property from the settlor (also called the grantor or trustor) to the trustee; and (2) a trust agreement between the trustee and the settlor (and sometimes the beneficiary) of the trust.
The deed to the trustee contains a provision which gives the trustee the express power to sell, contract to sell, mortgage, lease, or otherwise dispose of the trust corpus. The deed further provides that persons dealing with the trustee, as purchaser, lender, lessee, or otherwise, are fully protected in relying upon the authority of the trustee to act with respect to the trust corpus, and are not required to investigate the authority of the trustee. The beneficiaries are not named, though a name for the trust is usually identified. The deed also provides that the interest of the beneficiaries or any person claiming under them is limited to the proceeds from the disposition of the trust corpus. Finally, there is an express statement that the interest of the beneficiaries is personalty, not realty.
In the second document, the trust agreement, the settlor is also usually the beneficiary. The settlor/beneficiary contracts with the trustee, and the contract provides for limits of the trustee's authority, notwithstanding the apparent unlimited authority of the trustee recited in the deed. However, the trust agreement provides that it may not be recorded, and the trustee is prohibited from disclosing the terms of the trust or the names of the beneficiaries to third parties other than by court order or the written permission of all of the beneficiaries. Notwithstanding the apparent independent authority of the trustee contained in the deed upon which third parties are entitled to rely, as between the trustee and the beneficiary per the terms of the trust agreement, the trustee is given the power to dispose of the trust property to a third party only by written authorization from a majority (or sometimes all) of the beneficiaries, or at the end of twenty years, he is directed to sell any remaining property and to distribute the proceeds to the beneficiaries. The beneficiaries retain the right to possess, manage, and control the property, and the right to receive all income and proceeds from the property. As was provided in the deed, the parties agree that the interest of the beneficiaries is personalty only, and not realty. The trust is usually a living, revocable trust, with the settlor/beneficiary retaining the right to remove the trustee and to name another, or providing for successor trustees in the event that the original named trustee is removed or cannot serve for any reason. It typically provides for the beneficiaries to reimburse the trustee for his expenses, and to defend and indemnify him for any claims brought against him arising from his role as trustee.
Part of the theory of a land trust is that the trustee receives not only the legal title, but also the equitable title to the trust property. This distinguishes the land trust from the ordinary inter vivos trust. Equitable title is normally thought of as the right of the true owner to receive legal title at some time in the future, or to describe one’s interest in real estate that legal title does not define.11 It has been defined in case law in Texas as "an enforceable right to have legal title transferred to the holder of the equity."12 But in the case of a land trust, it is understood that the beneficiary will receive only the proceeds from the operation or sale of the property, not the title to the property itself. Therefore, by agreement of the parties the beneficial interest in a land trust is merely the right to possession, rents, profits, management, and the right to direct the trustee as to the disposition of the property, and such beneficial interest is personalty, not realty.
The states which have enacted land trust legislation specify that beneficial interests under a land trust are personal property. In other states, the doctrine of "equitable conversion" converts the seller's interest in the proceeds from a sale of real estate from a real property interest into personalty, that being the right to receive the proceeds of the sale. Part of the theory of the land trust is that since the trust agreement states that the trustee is to sell the property at the end of the twenty year term, the settlor's interest under the trust is converted from realty into personalty from the inception of the trust. In those states which have validated the use of land trusts, the courts will generally enforce the expressed intention of the parties to treat the interest of the settlor/beneficiary as personal property.13
The fact that the beneficiary has the power to direct the trustee as to the disposition of the property distinguishes it from the typical trust in which the trustee either has discretion to do what he thinks is appropriate, or is directed by the express provisions of the trust instrument as to what he is to do.
Because the beneficiary has the right to control and manage the trust property, Texas courts may consider the trust to be "dry" or "passive" and void the trust if it is challenged for some reason. But it seems clear that the trustee has some significant duties, if only in his obligation to sell the property at the end of the twenty year term.
BENEFITS OF A LAND TRUST
The potential benefits of the land trust are numerous, including the following identified by Bill Bronchick: privacy for the beneficiaries, asset protection by discouraging lawsuits, ease of transfer of the beneficial interests without affecting the title to the real estate; convenience of multiple ownership; avoidance of probate; ease of establishment and dissolution of the trust; and minimal tax reporting requirements.14
Under normal circumstances the nature and extent of the beneficial interest will be hidden from public view. The transfer of the property to the trustee is all that is visible to outside third parties from public records. It will often be assumed that the transfer is merely an estate planning vehicle in the form of a typical living trust to avoid probate. A search of current deed records by the name of the owner will only reveal that title is held by a trustee. Because the trust is given a name (usually relating to the address of the property), title to the property may be reflected on the computerized records in the name of the trust, or the name of the trustee, or both. Computerization of deed records frequently results in the truncation of the grantee’s name listed on the deed. If the name given for the grantee is the name of the trust, followed by the trustee's name ("1234 East Main Street Trust, I. M. Trustworthy, Trustee"), the abbreviated computer field which can be seen by the public may not even reflect the trustee's full name. The address for the grantee could show "c/o I.M. Trustworthy, Trustee."15
The trust itself if not a legal entity, but merely a relationship between two parties having different capacities.16 In Texas, legal title is not taken in the trust, only in the trustee. The trust cannot be sued, nor can it sue. If the trustee is careful to make it clear with third parties with whom he contracts that he is acting only in his capacity as trustee, then only the trust property will be liable for contractual obligations. On the other hand, because the beneficiary of the land trust retains the ability to manage and control the property, the land trust will not necessarily insulate the beneficiary from personal liability for negligence, violation of housing code or other statutes, or other actionable claims which take place on the property.
In any event, since the trustee may not reveal the identity of the beneficiaries absent a court order or the written consent of all of the beneficiaries, the privacy of the beneficial owners is preserved. Before a potential lawsuit is filed, many a contingency fee lawyer will perform a cursory asset search from public records. Use of the land trust probably would not reveal the beneficiary's interest. Hence, lawsuits may be discouraged, and pre-judgment settlements may be easier to negotiate based upon the assumption that the beneficiary has little or no assets. Even a post-judgment inquiry as to the beneficiary's interest in real property can be honestly answered in the negative. A truly savvy judgment creditor's attorney would need to inquire as to the judgment debtor's beneficial interest in a trust in order to discover the nature of the beneficiary's asset. Even then, the judgment creditor might have to file a separate action against the trustee to bust the trust. Even if a judgment lien is abstracted or an IRS lien is filed against the beneficiary, the lien will not attach to the real estate which is only in the trustee's name.
The beneficiaries could also issue a letter of direction to the trustee to execute an agreement with a management company to manage the property. This would limit the ability of tenants to discover the interests of the beneficiaries. Although Texas does have a statute which requires the disclosure of the owner upon request by a tenant or a government official, all that is required is the disclosure of the name and address of the holder of record title according to the deed records in the county clerk’s office.17
The beneficiaries could also form a separately capitalized legal entity with limited liability to act as the management company for the trust property, such as a corporation, limited liability company, or limited partnership. That might also help to explain the beneficiary's involvement in management of the property, as an employee of such management company. In Texas, management companies can legally execute leases and file eviction proceedings on behalf of the owner. Although a separate management company would have to be licensed as a real estate broker under Texas law to manage the trust property for consideration, the management company owned and staffed by the beneficiaries would not have to be licensed if there was no intention or promise of receiving any valuable consideration for the performance of the management services.18 But the use of a separate limited liability entity to manage all of the properties in which the beneficiaries have an interest would facilitate collection of rents, and obviate the necessity for several different trusts to have separate bank accounts. Banks would normally require that the trust instrument be provided prior to the establishment of a bank account for the trust, along with a tax identification number. A separate management company would enable the beneficiaries to be involved as officers, directors and shareholders of the management company with limited liability for their participation in the management of the trust properties, and to make distributions directly to themselves from the management company's bank accounts. It would also provide the beneficiaries with the ability to resort to the "higher authority" negotiating tactic when dealing with tenants and other third parties.19
Or the beneficiary could be named as a co-trustee after formation of the trust. The beneficiary could be designated as the managing trustee for purposes of property management, but still not be shown on the public deed records as an owner. Using one of the beneficiaries as a co-trustee exempts the originally named trustee from IRS reporting requirements.20
Since the creation of a trust does not require a filing fee, registration with state agencies, or recording costs, it would be fairly inexpensive for each property owned or acquired for the beneficiary to be placed into a separate trust. Since no burdensome daily responsibilities are imposed on the typical trustee in a land trust, the named trustee could be a trusted friend from another state, which would make it even more difficult for third parties to serve the trustee with legal process or to depose the trustee.21 Or the trustee could be a corporate trustee, to provide the beneficiaries with greater confidence.
Because the beneficiaries are not tenants-in-common, no right of partition exists. The death of one beneficiary will not force the sale of the property, or a change in the management of the trust’s real property. The personal property interest of the deceased beneficiary could pass to his heirs through devise or descent, or the trust instrument could provide for the disposition of the personal property interest of such beneficiary upon his death.
Because the beneficiaries are not partners, one beneficiary cannot bind another for trust obligations. And the trust agreement can prevent a creditor who does discover and succeed to one of the beneficiary's personal property interest from taking control of the property.
If there is only a single settlor who is also the sole beneficiary, and the trust is discovered and busted, one problem scenario is that the property is treated as though both the legal and equitable title is vested in the settlor/beneficiary22, and the client is no worse off than if he had retained title in his name in the first place.
One of the benefits of using a land trust is the ease by which the beneficial interests which are personalty can be transferred. Acknowledgment before a notary and recording of the interest is not necessary. Normal title problems which arise on the death, insanity or bankruptcy of a joint owner can be avoided. Usually all that is required is that the transferring beneficiary execute an assignment of his interest and forward it to the trustee. The record title to the real property is undisturbed despite the transfer of the beneficial interests.23
Using a land trust will keep the legal title to the trust property unencumbered in spite of personal judgments or IRS liens against the beneficiaries. Since the beneficiaries’ interests are personalty consisting of the right to receive the income or proceeds of the property, a judgment creditor may be able to get a turnover order or charging order as to the judgment debtor’s interest, but not a lien on the real property itself.24
The beneficiaries keep control of the property held in trust. Though the majority can direct the trustee as to the maintenance and disposition of the property, a minority cannot force the sale of the property.
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