Irrevocable Trust question for the Tax and Legal Pros!

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Irrevocable Trust question for the Tax and Legal Pros!

Rich Hupper
Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes

Thank you to anyone in advance that could help me with this loaded question / situation. 

My father use to own a piece of industrial land with two commercial rental bays on the lot. 

About 9 years ago he transferred title of the property into an irrevocable trust.

Now he is the trustee, myself and three other siblings are the beneficiaries. 

There is no mortgage on the property

Property taxes have been paid every year and are up to date. 

A mechanic tenant has rented one of the bays for the past nine years with no interruptions in rent payments. Roughly 2500/m.

My father has ran his wife's business out of the second bay. That business has never paid any rent to the trust.

The trust has never reported rental income. 

My father no longer wants to be the trustee and wants me to form an LLC to take the trustee position.

He wants my newly formed LLC to start reporting the current rental income so the company can can eventually mortgage the property.

The LLC will use this loan to construct 5 additional bays on the property.

If NOI right now is 1500/m and the property is used as collateral how long would it take to the newly formed LLC to qualify for financing as the trustee.

Also what % of the NOI should be dispersed to beneficiaries and how often?

Would I lose my beneficiary position because this is an LLC I created?

Would it be smarter to create two LLCs? One for the trust and one for the management company?

I do not know all the laws surrounding irrevocable trusts, so I am sure I am not asking the right questions. 

My main objectives here are:

1) not screw over any of my siblings

2) start growing a business that banks will enjoy lending to

3) improving the land with 5 additional bays

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Bill Gulley
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
10y

Rich, I believe what I'd do would be to form a new Trust, a copy of the old one but change the Trustee and transfer the property from the old Trust to the new one, start all over. I assume income and real estate taxes were paid individually by your dad in some manner. Terminate the old Trust.   I would not assume any entity that has been mismanaged in any role. You may have tax advantages of selling the assets to an irrevocable Trust on an installment basis. @Brandon Hall might address this.

I would also consider a new LLC, one with its purpose being the administration of the new Trust, your Trust accounting should not be commingled with your LLC business. I not sure I'd use an LLC anyway I'd probably act individually as the Trustee of a new Trust.

@Matthew Kreitzer can address the legal issues of the fiduciary duties and other matters of the Trustee and Trust, some issues I see are:

The business of the LLC being solely the administration of a Trust, a Trustee can certainly be paid from Trust income for the duties performed. My question would be the business nature, profitability of that business, is it really a business purpose? Is the LLC funded properly or is it a shell entity? I'm not sure of state law that may view your LLC as a Trust Company which would require licensing and financial requirements. There are also the liabilities of the LLC, a creditor can't reach the Trust assets through a Trustee, but they can the income earned or taken by the Trustee from its business. With an LLC you'll be hiring an attorney most likely for minor legal matters, like an eviction of tenants as opposed to acting individually as a Trustee. The more convoluted your plan the more expensive it will be. An LLC can be a Trustee, but how practical is it? What is you dad's reasoning?

I don't really see this as a DIY project, an attorney should advise you as well as a qualified accountant, a CPA.

@Rich Hupper   Happy New Year! :)

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  • David Tipton
    Los Angeles, CA · Member since 2015 · 197 posts · 59 votes
    10y

    Hi @Rich Hupper.  You should speak to a qualified attorney in your state as these questions are very specific to your situation.

    0Reply
  • Cameron Skinner
    Investor · Panama City, FL · Member since 2015 · 378 posts · 183 votes
    10y

    yeah way too many moving parts and veriables for anyone to answer your question without reading the trust documents and knowing the laws in your state.

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  • Matthew Kreitzer
    Attorney · Winchester, VA · Member since 2015 · 726 posts · 387 votes
    10y

    Let me make sure I have this right before I comment; Your father; Settlor and Trustor, wants to give you, a beneficiary of the trust, trustee powers, for the purpose of creating an LLC that will manage the rents, profits, and acquisitions for the Trust? Or does he want you to form an LLC, and he wants to make the LLC the Trustee....?

    0Reply
  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    10y

    @Rich Hupper

    Matthew can explain who's behind the door. Need to address his questions and mention him.

    As to borrowing, the Trust can borrow now, the change of Trustees is irrelevant to the lender, but the mess is your other business paid no rents. The only income is from the actual rents received and it will be covering 100% of expenses of the property, not just the leased bay. But, the long term tenant is great. 

    Construction financing for new bays will be different than a longer term loan, do the construction first, with rental experience behind you your pro forma rents will be considered on the construction loan.

    Another matter, are there other assets in the Trust?

    If the beneficial interest changes, that is a transfer as to loan underwriting and the lender may treat it as an acquisition rather than a sale, ownership of the LLC can be another issue but there shouldn't be any problem with an LLC being the Trustee from a lending standpoint. That means they will look more closely at who is running the show, experience and qualifications.

    Get the Trust and the estate squared away before obtaining a loan.

      Good luck :) 

    0Reply
  • Rich Hupper
    OP
    Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
    10y

    Hi @Matthew Kreitzer my father wants an LLC that I own to be the trustee of the trust.

    Hi @Bill Gulley the trust's only asset at the moment is the property and the two bays that are on it. 

    The trust itself has not filed any tax returns in the past 9 years. Would it have to file back taxes to be able to apply for a loan and mortgage the property?

    Or would it make more sense to nominate the newly created LLC the trustee, keep all the net operating income, so it could qualify for a loan faster, rather than dispersing any of it to the beneficiaries.

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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    10y

    Rich, I believe what I'd do would be to form a new Trust, a copy of the old one but change the Trustee and transfer the property from the old Trust to the new one, start all over. I assume income and real estate taxes were paid individually by your dad in some manner. Terminate the old Trust.   I would not assume any entity that has been mismanaged in any role. You may have tax advantages of selling the assets to an irrevocable Trust on an installment basis. @Brandon Hall might address this.

    I would also consider a new LLC, one with its purpose being the administration of the new Trust, your Trust accounting should not be commingled with your LLC business. I not sure I'd use an LLC anyway I'd probably act individually as the Trustee of a new Trust.

    @Matthew Kreitzer can address the legal issues of the fiduciary duties and other matters of the Trustee and Trust, some issues I see are:

    The business of the LLC being solely the administration of a Trust, a Trustee can certainly be paid from Trust income for the duties performed. My question would be the business nature, profitability of that business, is it really a business purpose? Is the LLC funded properly or is it a shell entity? I'm not sure of state law that may view your LLC as a Trust Company which would require licensing and financial requirements. There are also the liabilities of the LLC, a creditor can't reach the Trust assets through a Trustee, but they can the income earned or taken by the Trustee from its business. With an LLC you'll be hiring an attorney most likely for minor legal matters, like an eviction of tenants as opposed to acting individually as a Trustee. The more convoluted your plan the more expensive it will be. An LLC can be a Trustee, but how practical is it? What is you dad's reasoning?

    I don't really see this as a DIY project, an attorney should advise you as well as a qualified accountant, a CPA.

    @Rich Hupper   Happy New Year! :)

    1Reply
  • Matthew Kreitzer
    Attorney · Winchester, VA · Member since 2015 · 726 posts · 387 votes
    10y
    Originally posted by :

    can address the legal issues of the fiduciary duties and other matters of the Trustee and Trust, some issues I see are:

    The business of the LLC being solely the administration of a Trust, a Trustee can certainly be paid from Trust income for the duties performed. My question would be the business nature, profitability of that business, is it really a business purpose? Is the LLC funded properly or is it a shell entity? I'm not sure of state law that may view your LLC as a Trust Company which would require licensing and financial requirements. There are also the liabilities of the LLC, a creditor can't reach the Trust assets through a Trustee, but they can the income earned or taken by the Trustee from its business. With an LLC you'll be hiring an attorney most likely for minor legal matters, like an eviction of tenants as opposed to acting individually as a Trustee. The more convoluted your plan the more expensive it will be. An LLC can be a Trustee, but how practical is it? What is you dad's reasoning?

    I don't really see this as a DIY project, an attorney should advise you as well as a qualified accountant, a CPA.

    Bill has most of the legal issues summarized pretty well for you. There may be some additional considerations at play here though. Not all states uniformly allow for LLCs to serve as Trustees. I do have some concern about the identity of the proposed LLC though. Is it a disregarded entity? (In other words, is it is a closely held LLC of which you are the only member?) What other business is the LLC engaged in? If this is a closely held LLC you may be under some extreme scrutiny by creditors at some point down the line. I've had to invalidate my own fair share of Irrevocable Trusts when Settlors begin to try and work around the irrevocable nature of it and try to retain certain powers they should not be exercising. Not only that, but you may run the risk of your personal assets being subject to lawsuit [depending on how your LLC is currently structured and operated].

    Do I think having a LLC act a as a Trustee is a blanket bad idea? No, not at all. If done correctly, it is a great asset protection plan. It allows for your father to accomplish his goal of outside management. You could bring in new LLC members to take care of the property.

    Consult a local attorney to figure out the pitfalls in your state.

    1Reply
  • Rich Hupper
    OP
    Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
    10y

    @Bill Gulley @Matthew Kreitzer

    Thank you both for your replies. I am going to meet with an attorney tomorrow to discuss the best course of action. My ignorance about trusts in general are preventing me from fully understanding your responses. 

    I will update the post when I know more. 

    Also perhaps I could hire @brandon hall for his tax services.

    2Reply
  • Rich Hupper
    OP
    Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
    10y

    @Matthew Kreitzer

    Bill has most of the legal issues summarized pretty well for you. There may be some additional considerations at play here though. Not all states uniformly allow for LLCs to serve as Trustees. I do have some concern about the identity of the proposed LLC though. Is it a disregarded entity? (In other words, is it is a closely held LLC of which you are the only member?) What other business is the LLC engaged in? If this is a closely held LLC you may be under some extreme scrutiny by creditors at some point down the line. I've had to invalidate my own fair share of Irrevocable Trusts when Settlors begin to try and work around the irrevocable nature of it and try to retain certain powers they should not be exercising. Not only that, but you may run the risk of your personal assets being subject to lawsuit [depending on how your LLC is currently structured and operated].

    Do I think having a LLC act a as a Trustee is a blanket bad idea? No, not at all. If done correctly, it is a great asset protection plan. It allows for your father to accomplish his goal of outside management. You could bring in new LLC members to take care of the property.

    Consult a local attorney to figure out the pitfalls in your state.

    I would be the only member of the LLC, and it has not been created yet. The LLC will be a commercial property management company and once I have my broker license it will also be a brokerage so I can lease and sell properties. I want this trust to be my company's first client.

    0Reply
  • Matthew Kreitzer
    Attorney · Winchester, VA · Member since 2015 · 726 posts · 387 votes
    10y
    Originally posted by :

    I would be the only member of the LLC, and it has not been created yet. The LLC will be a commercial property management company and once I have my broker license it will also be a brokerage so I can lease and sell properties. I want this trust to be my company's first client.

     Will you be hiring a property manager as a W2 employee or will you be handling the property management as the sole member? 

    The reason I'm asking these questions is that if you are a sole member LLC, I could see an enterprising debt collection firm attempting to challenge you in court depending on a number of facts related to your father. One area I may look at for preparation to speak with an attorney is the Uniform Fraudulent Transfer Act. It can give you some basic information on practices that could cause your single member LLC some troubles. In my state, at least, I would tell someone to take extreme caution in this kind of situation and make sure their record keeping is on point. If they can afford it from the rents and profits, consider hiring a property manager.

    None of this would apply necessarily in your particular state, and please don't act on any of these ideas. (Since the law may change in your state) Just some food for thought when you go to talk to your own, local attorney.

    0Reply
  • Rich Hupper
    OP
    Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
    10y

    Hello Bill and Matt

    Just to update the post, I met with an attorney. He is having my father resign as the trustee, and creating a new trustee which will be a sub chapter S corp with a 100,000 shares that I will own. After the new trustee is created he advised us to immediately obtain insurance on on the entire trust, and have all future tenants carry their own insurance. 

    He also advised me to start marketing the commercial property now on loopnet, so I can go to the bank looking for a loan with contracts in hand. He also suggested finding someone who is looking for a land lease ( I need to learn more about what this entails ).

    He then advised, that the sub chapter s corp trustee contract with an "empty hat" management company that carries its own insurance policy. 

    This empty hat management company will just be in place to further secure the trust, where if a claim is ever filed where damages exceed it's insurance policy, this company can file bankruptcy. 

    As for creating my own company, this will be on hold until I have found someone looking for a land lease or tenants looking for long term leases in proposed rental bays. 

    Do either of you gentlemen have experience working with commercial rentals? 

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