As the next economic downturn approaches, interest in hiding recorded ownership increases. This article explains two different trust arrangements owners use to attempt this, and the ramifications of each.
Would you ever consider allowing another individual to hold title to your property for you?
This is not an uncommon situation, and typically occurs in recessionary periods when owners are interested in hiding property ownership to avoid creditors — including lenders holding mortgages — and mortgage alienation clauses.
But does it work? Is it considered fraudulent? And does this practice actually keep an owner’s name off public records and help them avoid the consequences of money judgments and ‘due-on’ calls?
An LLC holds title in trust
The purpose of a trust vesting arrangement is to keep one’s name from appearing on record as owning a parcel of real estate. Limited liability companies (LLCs) are the most straightforward way to complete this type of vesting and allow the owner to maintain full control over title to the property.
However, the use of an LLC to hold real estate assets was neither designed nor intended to be employed as a place to permanently hide an individual’s personal wealth from creditors. Rather, use of an LLC allows real estate vested in the LLC to remain undisturbed in the face of an individual member’s financial adversity, and vice versa. Thus, the “ownership” of the property is not hidden and no fraudulent transfer of property is involved since it is vested with title in the LLC and the debtor is the owner, solely or partially with others, as a member owning the LLC.
Creditors seeking the location of a debtor’s assets held in an entity such as an LLC need to look beyond the public records to determine if the debtor has any ownership in an LLC. This information is needed to obtain a court-issued charging order to attach the debtor’s interest in the LLC. Again, the creditor cannot attach and foreclose on the property vested in the LLC, they may only attach and sell/acquire only the creditor’s membership interest in the LLC.
Consider an owner of real estate who transfers title to a property into an LLC they created. The owner receives a percentage or all of the ownership interests in the LLC as a member for the conveyance — fair value for the transfer since they became an owner/member of the LLC which now owns the real estate. In this instance, the conveyance is not fraudulent. The owner has merely exchanged their interest in the real estate for an interest in the LLC of equal value. Full value is received and no tax liability is incurred on this tax-free exchange. [26 United States Code §721]
In essence, the owner has substituted their real estate vesting for a stock-like membership position in the LLC. The owner still owns a value equal to the equity in the real estate they transferred, just in a different form. The nature of the owner’s ownership interest merely changes from one of real property to one of personal property (shares in an LLC).
Further, this simple change in vesting inherently makes it much more difficult for creditors to locate, attach and judicially sell the debtor’s assets to satisfy a claim for money.
When vested title is in the name of an LLC, the individual named as the debtor on a recorded abstract of judgment is not the vested owner of any real estate. Further, the change in vesting makes the real estate, now the asset of an LLC, much more difficult — but not impossible — for the creditor to reach due to:
- the charging order and judicial sale process;
- nonvoting status of the creditor if they do foreclose on the LLC interest held by the debtor; and
- the buyout provisions in the LLC operating agreement.
As the creditor attempts to locate and attach the debtor’s assets, the LLC is able to continue its business of renting, selling or encumbering the property. On attaching the member’s interest via a charging order or appointment of a receiver, the LLC distributes net proceeds from operating income to the judgment debtor under the LLC operating agreement. On foreclosure of the debtor’s membership share in the LLC, the debtor becomes a nonvoting member in the LLC.
In an LLC vesting, there is an annual cost of maintaining the LLC as an entity in California, usually around $1,000-$1,500 for annual taxes and filings. Whereas, vesting title in trust with another person incurs no expense.
An individual holds title in trust
A property owner may be tempted to ask an individual (or entity registered to do business in California) to hold title to the property in trust for the owner, vested in the individual’s name as trustee to avoid the extra steps and costs of forming and maintaining an LLC. But this requires a certain bit of, well, trust in that individual.
One way this is sometimes done is through a revocable inter vivos (living) trust, usually carried out with a family member.
A living trust agreement is a title holding arrangement which is not operative and has no legal, financial or tax consequences until death. [See RPI Form 463]
Further, it’s a popular misconception that owners may use revocable living trust vestings to avoid their creditors. This is completely unfounded — a trust vesting is not a debt shield or an asset preservation vesting. Creditors can directly reach property vested in the owner’s revocable living trust, both during the owner’s lifetime and after their death.
Living trusts do provide a benefit: their ability to perform the same functions as a will while avoiding probate procedures. Given the nature of California probate proceedings, the advantage of the alternative trust vesting is substantial, both in conveyance time and handling costs.
But using a living trust with the goal of avoiding creditors does not attain that objective.
Trust vesting today
At the start of 2019, very few individuals are pursuing alternative vestings such as trust arrangements or LLCs to deter or avoid creditors or existing mortgage lender ‘due-on’ enforcement. However, as we head into the next recessionary period — forecasted to arrive in 2020 — expect to see greater interest in these types of arrangements.
But avoiding debts or ‘due-on’ clauses by hiding ownership is not foolproof. Placing title to a property in trust simply kicks the can down the road. Thus, it becomes more difficult for the creditor to locate the owned asset held in another person’s name and eventually attach the property and judicially foreclose, or the existing mortgage lender to determine whether their ‘due-on’ clause has been triggered.
Still, this hide-and-seek activity will pick up in the coming years as the economy slows and creative owners seek ways to avoid losing their properties when they can no longer pay their debts and frugal buyers seek ways to take over low interest rate mortgages on property listed for sale. Consider the LLC entity as the most practical and proper way for an owner to distance creditors from their assets — if that is the objective.