STRUCTURING TITLE TO REAL ESTATE INVESTMENTS
You’ve decided it’s time to put some of the spare money under your mattress toward investing in real estate. Before jumping in by yourself, consider whether it’s smarter to go it alone or invest with a group. Remember to review your “EFB”: estate planning, financial planning, and business planning. Your EFB will serve as a guide whether to acquire real estate as an individual, a partnership, or another entity. Regardless of whether you are a solo investor or invest with a team, consider how you plan to hold title to the real estate. “Holding title” is really just a lawyer’s fancy way of saying: “who has an ownership interest in the property.” Consider the ownership interest in any property as a pie, and that the title determines how that pie is cut up and distributed.
Trusts. For individual ownership, a revocable living trust or an Illinois land trust are two alternatives that can provide for future ownership succession without going through probate. Illinois law now also provides for a payable-on-death deed that allows the owner to designate a successor beneficiary upon death.
Joint Tenancy. Often, couples hold title to a residence or vacation home as joint tenants with right of survivorship. Each couple owns an equal portion of the pie. Under this model, the surviving person gets the whole pie in the event the other dies. The property does not have to pass through probate (where creditors may try to take a piece of the pie).
Tenancy by the Entirety. In 26 states, including Illinois, a husband and wife may title their primary residence as Tenancy by the Entirety (“TBE”). TBE is similar to joint tenancy with right of survivorship. In a TBE, neither spouse has any part of the pie, and instead, the pie is held by the couple, together, as a married couple. That way, if one spouse owes a debt to a creditor, the creditor cannot sell or transfer that spouse’s interest in the property to satisfy the debt. Divorce dissolves the TBE, and death terminates the TBE with the automatic transfer of the deceased spouse’s interest to the surviving spouse. Some of the 26 states that provide for TBE also make it available to same-sex marriages. Illinois law also allows a TBE to be held by the revocable living trust of each spouse.
Tenants-in-Common. Another title method is Tenants-in-Common (“TCE”). Holding title as TCE allows each person to hold a portion of the pie. A key difference here is that when a person holding interest in the property dies, their piece of the pie does not automatically pass to the other individuals who have interests in the property. This method is commonly used by family members who share ownership of a vacation property to define the share of each family member’s rights and obligations.
Company or Partnership. A company, partnership, or limited liability company may also hold title to an investment property. The entity agreement (which has different names depending on the entity) defines the relationship among the owners of the entity. The entity agreement sets forth who can act in the entity’s name to purchase or sell or manage the property. The entity agreement will also determine how the pie is distributed among the equity owners, and how the owners can transfer their pieces. Holding title in the name of an entity may also shield the interest owners from personal liability for some, but not all, kinds of claims. The “liability shield” can be particularly beneficial when leasing investment property.
Single Purpose Entities. If investing in multiple properties, consider having title to each property held in a separate entity. Separate entities for each property may provide a liability shield between properties, preventing a party from using another property as an asset to pay the debts of a separate property. For example, if Company A owns two lots, Lot 1 and 2 and if Company A has a debt, a creditor can force a sale of both lots. But, if Company A owns Lot 1 and Company B owns Lot 2, a creditor has a more difficult time selling Lot 2 to satisfy Company A’s obligations, because it’s owned by a separate company. In this situation, Companies A and B are called “single purpose entities” or “SPE’s”. To bolster the liability shield, the SPE should handle each property’s assets and liabilities separately.
Conclusion. Investing in real estate requires a careful analysis of the tax, liability, and transferability characteristics of various ownership structures. Most importantly, before investing in real estate it is always prudent to consult with your attorney, financial planner and accountant.
By: Joan T. Berg
REVISITING AN OLD TRUST: DECANTING IRREVOCABLE AGREEMENTS
Trusts have existed for a long time, first recognized under English common law around the time of the Crusades. While the uses and structures of trusts continue to evolve, it has been a near immutable assumption that only revocable trusts could be modified and, conversely, the terms of an irrevocable trust were permanent. This is rapidly changing, with 25 states (including Illinois) in the past decade enacting or expanding statutes to allow irrevocable trusts to be modified through a process known as decanting.
Why Decant? There are many reasons and motivations for decanting an irrevocable trust. One image is that of a financially insolvent beneficiary who is seeking larger distributions. Alternately, it may be a parent wanting to better protect the inheritance left to a child or grandchild who has creditor issues, lifestyle issues or is in a failing marriage. There are many less obvious reasons to modify an old trust that arise when changed circumstances mean the trust terms do not fit the best interests of the beneficiaries. For example, a taxpayer not facing an estate tax on their death may wish to restructure a trust in order to eliminate large capital gains taxes for the trust beneficiaries. Likewise, a trustee may want to move the trust from a state that taxes trust income to a state that does not. Other reasons to decant are to change a support trust to a discretionary trust or to extend the trust term to improve asset protection, or to create a supplemental needs trust for a disabled trust beneficiary. For example, many trusts contain commonly used language stating that assets are to be used to support a beneficiary. In some states, this language may subject trust assets to a child’s ex-spouse following a divorce or to certain classes of creditors. Yet another reason to decant is to improve administrative efficiency by dividing a trust with multiple beneficiaries who do not share a common investment or financial philosophy or by reducing administrative costs by combining multiple trusts for one beneficiary. Other reasons to decant are to plan for the succession of trustees, broaden the Trustee’s ability to make discretionary distributions, or to increase protections for the Trustee.
Considerations When Decanting. The Trustee typically initiates a decanting, although some trusts allow a trust protector or other fiduciary to exercise this authority. The Trustee should begin by clarifying the goals and factors involved, such as the desired changes to the trust; the people involved; and the rights of beneficiaries to receive notice, review the trust documents, and to receive information about the trust assets. With this information in mind, make an analysis of applicable state decanting law; if this law is inadequate, it may be desirable to move the trust situs to another state to achieve the desired result if the trust may be moved. The Illinois statute governing decanting has certain limitations on the scope of the new trust, depending on the distribution provisions of the old trust.
Implementing the Decanting. Once the Trustee is ready to implement a decanting, an attorney initiates the process by creating a new trust agreement and gives notice, as required, to the trust beneficiaries. For example, the Illinois statute requires a 60-day notice specifying the proposed trust changes, which often involves giving beneficiaries copies of the old and new trust documents. If no beneficiary objects, depending on the circumstances, such as beneficiary consent, the age and legal capacity of the trust beneficiaries and the terms of the trust, the Trustee is able to decant without requiring court approval. If a beneficiary objects to the decanting, a court proceeding can be initiated.
Tax Implications. There are a myriad of potential tax implications when decanting that depend on factors like: the rights of a beneficiary to object to the decanting; the change in a beneficiary’s rights; a provision in the trust that may make the trust taxable in the estate of the person that created it or the estate of the trust beneficiary; and the applicability of generation skipping tax. Review the tax implications of any potential changes to the trust before making the decision to decant,
Conclusion. Not all irrevocable trusts are drafted with the same flexibility and old trusts sometimes do not fit current circumstances. States have quickly adopted decanting as a valuable option for bringing trusts current with changed circumstances and the current needs of the trust beneficiaries. Decanting is another tool to effect the modification of an irrevocable trust, which can also be effected through family settlement agreements through virtual representation, or other techniques, depending on the circumstances.
Introducing James D. Voigt
Jim Voigt has joined the Firm as a partner focusing on serving a wide array of small business needs as clients launch, grow, and eventually exit their businesses. He assists clients with their corporate structures, general contract matters, mergers and acquisitions, commercial lease negotiations, and provides guidance to clients involved in shareholder or other ownership disputes. He was previously with Lavelle Law, Ltd.
An article written by Bruce E. Bell, “How To Give Away Your Company’s Stock To Your Kid,” is now featured on Forbes.com.
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