Land Trust Traps for the Unwary Investor

I received eleven calls this week from real estate investors who wanted to set up land trusts to protect their real estate investments.  Understand that it not uncommon for me to receive a few calls each week on this topic but 11 within three days.  Did this topic hit PR-Newswire? To make these calls even worse, each and every caller was confused as to why and how to properly use a land trust in investing.   So here is my land trust lesson beginning with the two most common myths.

Land trusts do not offer asset protection
Land trusts hide your ownership of real estate

A land trust does not provide asset protection.  To obtain asset protection from a trust the trust must be irrevocable i.e., you can not modify or cancel the trust after it is created, your interaction with the trust assets are severely restricted, and you cannot be a trust beneficiary.  A land trust does not fall into the irrevocable category.  The land trust is in fact just the opposite – revocable.  It has been a fundamental fact of English and U.S. common law for hundreds of years that a person cannot protect his assets from his creditors by putting property into a trust that the person fully controls.  Further, the person is not protected from the trust’s creditors i.e., if harm occurs with the trust the trust owner is responsible.  Face it, a land trust by itself will not protect the investor.

Land trusts do not always hide property ownership.  To keep your ownership of real estate private two things must occur – you take title to the property in the name of the trust using a nominee trustee and you purchase the property for cash.

Title to assets held in trust are typically held by a trustee in the name of the trust e.g., Clint Coons as Trustee of the Bigger Pockets Trust Dated 9.23.10.  As you can read, if I am trying to mask my property ownership I should avoid serving as the trustee of my own trust.  Therefore, the sophisticated investor will use a trusted friend or attorney as his initial trustee.  I write initial trustee because when title is recorded in the trust you may want your trustee to resign and you assume the position.  (This change is trusteeship does not get recorded so anyone looking at your trust would assume the initial trustee is still serving.)  Unfortunately anonymity is a two-prong test and using a nominee trustee only satisfies the first prong; the more difficult is buying for cash.

If you are fortunate to have sufficient wealth to purchase all of your investments for cash then you can achieve anonymity with a land trust; however, if you are like the vast majority of investors and require financing then all bets are off.  When you purchase real estate using financing the lender will seek a deed of trust or mortgage to be filed against the property.  Either of these documents will let the world know that you, as the purchaser, is liable on a note to the lender and the lender has secured its interest against your property.  This is where the anonymity begins to unravel.  If a competent attorney performs a thorough asset search you may not show up on title (you nominee trustee appears) but you will show up on the financing documents leaving one to reasonably assume that as the party responsible for the debt you most likely have an interest in the property.

As you can see the land trust will not provide the two oft touted benefits quoted by many real estate gurus.  This does not imply that the land trust does not have a place in the investor’s arsenal for in fact it does and in the current investing climate it is more important than ever.

See Part 2: Why and how you should use a land trust for real estate investing.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.