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This article examines the use of the living trust vesting, which avoids probate supervision of a deceased owner’s estate, and distinguishes the living trust from other trusts.

A review of vestings

A broker is working with a prospective buyer who has decided to make an offer to purchase real estate located by the broker. The broker begins to prepare a purchase agreement.

Before entering the name of the buyer on the purchase agreement in order to identify the buyer responsible for the offer and the source of the good faith deposit, the broker asks the buyer:

  • How are you going to take title to the property? and
  • How are you going to fund the good faith deposit?

The buyer informs the broker he will take title in the name of his family trust, legally titled a revocable inter vivos trust agreement and simply called a living trust. The deposit toward the purchase price/down payment will be by check drawn on a bank account in the buyer’s name as trustee for the living trust.

As a result of the trust vesting requirement, the buyer is properly told he will need to provide a copy of the trust agreement (or at least the first page) on opening escrow. Escrow will need a copy of the trust agreement for the correct name and spelling of both the trustee and the family trust when preparing instructions and the grant deed vesting title in the living trust.

The broker, aware the buyer will fund a portion of the purchase price from the net proceeds of a new loan, is now concerned about the vesting the lender will demand to fund and record the loan.

Since the broker knows the lender will require the buyer to take title in his own name, the broker inquires into the buyer’s legal status:

  • Are you single, married, unmarried or widowed? and
  • Will the property on acquisition be separate property, community property or a property jointly owned with others?

The buyer informs the broker he is married and the property acquired will be community property.

To avoid vesting complications on closing, the broker now informs the buyer that the lender (and the title company) will require both spouses to enter into the loan agreements, including the trust deed. Lenders will not accept a living trust as the borrower since a living trust is not a person (or legal entity).

Thus, the buyer and his spouse will first be required to take title in both their names – husband and wife – as joint tenants, as community property or as community property with the right of survivorship.

Accordingly, the broker enters the names of both the individual and his spouse as the buyers on the purchase agreement.

After the spouses take title and the lender’s trust deed is recorded, a grant deed further conveying the property from the spouses as “husband and wife” into the family trust vesting can be recorded.

The escrow officer will be instructed to prepare both grant deeds:

  • one from the seller to the buyers; and
  • one from the buyers to their family trust, to be recorded after the lender’s trust deed is recorded.

This “double deeding” instruction is to be part of the mutual escrow instructions signed by the seller and the buyer. The lender on receiving a copy of the instructions will have notice (required by federal mortgage law) of the further transfer into the trust vesting.

Also, escrow will be advised the policy of title insurance is to be issued in the name of the husband and wife as the vested owners. However, only the American Land Title Association (ALTA) homeowner’s policy of title insurance automatically provides coverage for a later transfer into the revocable inter vivos trust vesting, even though only the husband and wife are named as the insureds. All other policies require an endorsement to insure a later transfer to the living trust.

Living Trust Considerations

Property Tax Reassessment: Transfers of title to real estate by individuals into their revocable living trusts are exempt from reassessment. [Calif. Revenue and Taxation Code §62(d)]

Editor’s note — In an environment of financially strapped counties and trigger-happy assessors, the owner should get prior written approval from the assessor before conveying the property into trust.

Due-on-sale: A conveyance of real estate into any trust vesting triggers the due-on clause, requiring written pre-conveyance consent by lenders with due-on clauses in their trust deeds. [12 Code of Federal Regulations §591.5] Editor’s note — Federal regulations requiring lender approval on owner-occupied, one-to-four residential units contradict federal codes, which exempt transfers to revocable living trusts from due-on-sale enforcement. However, in the 1990s, the discrepancy was moot as due-on-sale is primarily an economic issue, not the legal issue it once was. As demand pressure on interest rates subsides, old loans will typically have a higher rate than new loans, creating no incentive for lenders to call loans due or recast them on transfer of title to a living trust. [12 United States Code §1701j-3(d)(8)]

Probate Avoidance: Trust provisions limiting the right of a successor trustee or beneficiary to petition the probate court to resolve disputes are unenforceable. [In re Estate of Parrette (1985) 165 CA3d 157]

Tax Aspects: All tax consequences remain with the owner of the property, unaltered by the trust vesting – including income and expenses, interest, depreciation, profit and loss, 1031 and 1040 reporting, the $250,000 per person residential profit exclusion, rental operating losses, etc. However, the appointment of a trustee other than the owner to operate the property establishes the trust as a separate taxable activity, and the trustor will lose the personal tax benefits from the real estate.

Family Partnership: Community assets vested in the name of a limited partnership or limited liability company (LLC), with the husband and wife owning the partnership as partners or the LLC as members, allow their capital ownership interests in the company to be vested in the living trust. The same vesting holds for stock in a corporation, trust certificates, bonds, and notes and trust deeds owner by the husband and wife.

Surviving Spouse: A qualified terminable interest in property (QTIP) conveys to the surviving spouse a life estate in the deceased spouse’s property, without the ability by the surviving spouse to amend or revoke the deceased’s distribution of the fee simple to, for example, their children. The surviving spouse must file a declaration with the Internal Revenue Service (IRS) stating the life estate is a QTIP to exempt the property from the deceased spouse’s estate taxes under the marital deduction. However, the property will be included in the surviving spouse’s taxable estate on death. [Internal Revenue Code §2056(h)]

Power of Attorney: The delegation of real estate management to another during the owner’s lifetime should be accomplished by a property management agreement, not a revocable living trust or power of attorney.

Reasons for a trust

An individual owner of property, real or personal, creates a revocable living trust to hold title to the property, primarily:

  • to accommodate the distribution of the owner’s estate which remains at the time of the owner’s death, without resorting to probate proceedings under a will; and
  • to retain the interim ability to sell, encumber, lease or remove the property from the trust vesting without the debilities imposed by other estate planning vestings, such as joint tenancy or community property vestings.

Alternatively, spouses who want to best accomplish the passing of their community property to the surviving spouse should use a right of survivorship vesting such as a joint tenancy or the community property with right of survivorship vesting. These survivorship vestings eliminate the need for conveyance on the death of a spouse. Also, under these vestings the right of survivorship can be individually severed – eliminated – by either spouse by deeding their interest to themselves with a declaration stating they are terminating the joint tenancy or community property with right of survivorship vesting.

The deed to oneself of a fractional ownership interest alters the vesting but definitely does not alter the underlying nature of the ownership, be it a community asset or separate asset. What remains after the severance by a husband or wife of a right of survivorship vesting is a simple community property vesting.

Judgment attaches to trust vesting

A popular myth maintains that owners can use revocable living trusts to avoid their creditors. This is completely unfounded – the trust vesting is not a debt shield or an asset preservation vesting. Creditors may still reach property vested in the owner’s revocable living trust, both during the owner’s lifetime and after death. A revocable living trust is not a separate vesting or legal entity different from the owner, such as is a partnership, limited liability company (LLC) or corporate form of ownership. [Calif. Probate Code §18200]

The singular advantage of a revocable living trust is its ability to perform the same functions as a will while avoiding probate. Given the onerous nature of California probate proceedings, the advantage of the alternative trust vesting is huge, both in conveyance time and handling costs. A trust agreement is nothing more than escrow instructions to the successor trustee to deed properties to named beneficiaries. Probate is litigation, service of process on heirs and courtroom actions over a long period of time, not just a few weeks.

Consider a creditor who records an abstract of judgment which attaches as a lien to all real estate owned in the county by the judgment debtor. A parcel of real estate in the county owned by the debtor is vested in his revocable inter vivos (living) trust. The parcel is subject to a first trust deed.

A second trust deed to secure a loan is later recorded on the real estate vested in the revocable living trust.

Ultimately, the first trust deed holder forecloses. The property is sold at a trustee’s sale for a price in excess of the amount due on the first trust deed. The judgment creditor demands the excess sales proceeds, claiming his judgment lien naming the debtor which is attached to the real estate vested in the debtor’s revocable living trust is second in priority to the first trust deed.

The second trust deed lender claims he is entitled to the excess funds since he was a good faith encumbrancer of the trust asset, unaware of the judgment recorded against the debtor who was the true owner of the property held in trust.

However, the judgment creditor is entitled to the excess proceeds. The second trust deed holder has constructive notice of the recorded judgment against the debtor who is the owner (beneficiary) of the real estate vested in the revocable living trust. A review of the trust agreement controlling the trustee who holds title would reveal the true owner’s identity. [Bank One Texas, N.A. v. Pollack (Bank of Montreal) (1994) 24 CA4th 973]

Community property, separate trusts

A husband and wife should each establish separate trusts for their half of the community property. The other spouse should be named as successor trustee.

Although spouses can jointly deed their community property into one trust, the joint trust is substantially more complex and replete with distribution and trust management complications after the first death.

The complexities involved with spouses deeding into the same trust are comparable to the folly of attempting to use one set of escrow instructions to handle the sale/exchange of properties owned by two separate parties. Two escrows should be created.

Placing each spouse’s community property interest into separate trusts incurs no financial, legal or tax disadvantages, and in no way alters the character of community property. The trust vesting is just another way to vest community property. [Calif. Family Code §761]

Establishing the trust

Any trust created for the purpose of holding title to real estate is only valid if the trust relationship with the trustee is declared in writing. [Prob C §15206]

Fortunately, only a minimal writing, called a Declaration of Trust or trust agreement, is required to establish a viable living trust.

The owner must sign and record grant deeds conveying his real estate into the trust vesting.

The elements necessary to enter into a living trust agreement include:

  • the owner’s declaration to establish a trust as the trustor (sometimes called the settlor) [Prob C §15201];
  • identification of a trustee (usually the owner) to manage title to properties vested in the trustee as instructed by the trust agreement [Prob C §15200];
  • actual conveyance of property (called the corpus or trust property) to the trustee [Prob C §15202]; and
  • successor(s), called beneficiaries, to receive the trust property on death of the owner. [Prob C §15205]

Thus, the trust agreement becomes a title holding arrangement which has no legal, financial or tax consequences until death. [See first tuesday Form 390]

The only activity that remains after entering into the trust agreement is to convey title to property into the trust vesting.

The owner must sign and record grant deeds conveying his real estate into the trust vesting. Otherwise, the property will remain vested in the owner on his death, and the trust will be useless as it was not funded and has nothing to further convey.

The property vested in the trust estate is listed in a property distribution schedule attached to the trust declaration, usually called Schedule A. [See Form 390, Schedule A accompanying this chapter]

In addition to identifying the trust real estate, the schedule specifies the successors of the owner to whom property will be distributed.

Trust agreements should not be recorded. However, consider having the trust agreement notarized to verify the owner signed the document when the title company asks for it before issuing an insurance policy.

Amending Schedule A

An owner is able to add properties to Schedule A attached to the trust agreement at any time. To do so, the owner conveys properties to the trust and adds the properties to the list in Schedule A, naming the successors who are to receive the properties on his death.

Conversely, an owner removing properties from the trust and deleting them from Schedule A, or changing successors to a property, should re-draft Schedule A in its entirety. Attach the new draft to the original trust agreement after removing the old Schedule A.

Underage successors

If trust real estate is conveyed to an underage successor on the owner’s death, a guardian will be appointed by the court to manage the property.

The owner might also consider including a clause in the trust document to avoid the distribution of trust property directly to successors under a certain age.Individuals under the age of 18 can receive title to real estate, but cannot execute a valid contract or conveyance relating to the real estate. [Fam C §§6500; 6701(b)]

Thus, if trust real estate is conveyed to an underage successor on the owner’s death, a guardian will have to be appointed by the court to manage the property. [Prob C §1514]

To prevent the underage successors from being subjected to a court-appointed guardian to administer the property received, the owner can simply require the trustee (or someone else) to retain title and manage the property until the successor reaches the age of 18.

Of course, an owner might not want the property to wind up in the hands of an 18-year-old either. Some owners prefer to prevent distribution of property to their children until the children reach a more mature age, for fear a younger, less experienced successor will waste or misuse the property, or is already a proven spendthrift.

Successor trustees

Critical to the distribution of properties on death of the owner is:

  • the naming of successor trustees in the declaration of trust agreement; and
  • the preparation of an exhibit (attached to the trust agreement) listing the properties that are vested in the name of the trustee, followed by the name(s) of the individual(s) who are to receive the properties on the owner’s death.

Variations on the distribution of the owner’s property exist, such as having a list of beneficiaries who will “share and share alike” all the properties vested in the name of the trustee; or selling all the assets vested in the trustee and distributing the net proceeds of the sale to the named beneficiaries based on the percentage given each of them in the trust agreement, etc. The variations are limited only by the simplicity or complexity sought by the owner, including the establishment in the living trust agreement of a management trust to own and operate the properties and distribute the income for a period of time after death.

The trust vesting has no effect on the nature of the property, whether the property is transferred into the trust or transferred out of the trust.

A transfer of community assets, such as the disbursement of cash savings and borrowings to purchase a property, or the vesting of the property acquired in the “[name of the trustee] for the [_____] family trust,” does not alter the community asset nature of the property. The trust vesting, like a joint tenancy vesting, has no effect on the nature of the property, whether the property is transferred into the trust or transferred out of the trust. It remains community property at all times since it was acquired or transmuted to community property during the marriage. [Fam C §761]

Also, the vesting of community property in a revocable inter vivos trust – the living trust – avoids any conflicting attempts at distribution under a will or by intestate succession should a will not exist. The trust agreement provisions control the distribution of properties vested in the trust on death. [Prob C §13504]

Taxwise, a living trust offers no ability to accomplish greater or lesser tax results than can be attained under a will. Thus, the revocable inter vivos trust is a complete substitute for a will – for those assets vested in the trust at the time of the owner’s death. A will controls the distribution of assets vested in the name of the deceased at the time of death.

If the spouse of the deceased is the successor and the property is community property, the surviving spouse receives the entire property with a cost basis fully stepped up to the property’s market value on the death of the spouse. The surviving spouse does so in spite of the vesting given the community property, be the property vested in a living trust, husband and wife as joint tenants or husband and wife under either community property vesting. It is community property, period. [Internal Revenue Code §1014(b)(6); Revenue Ruling 87-98]

Trust entities and trust relationships

Real estate brokers employed by principals to act as their agents are subject to the duties of a trust relationship while the agent holds or manages property owned by the principal.

Relationships in real estate transactions frequently include an agency relationship which rises to the level of a trust relationship. A trust relationship is established and imposes a duty on the agent who holds title, or who is to deliver the property held in trust to others, subject to instructions given to the agent by the principal who owns the property. Real estate brokers, escrow companies, title companies or banks operating a trust business and attorneys are commonly employed by principals to act as their agents, subject to the duties of a trust relationship which is imposed while the agent holds or manages property owned by the principal.

A “trust company” is any corporation or bank which is authorized to engage in the activities of a trust business.

A trust business exists when a person acts as an executor, administrator, guardian or conservator of estates, or as assignee, receiver, depositary or trustee by the appointment of the court or for any purpose permitted by law. [Calif. Financial Code §106]

A trust business in California is a distinctly different engagement with the public than the relationship established by the activities of a business trust.

Business trusts are engaged in general business, not in a trust business. The relationships created under a business trust arrangement do not include the trust relationship between a principal (beneficiary) and his agent (trustee).

A business trust is an entity which cannot be established under California law. A scheme does not exist for the creation of a business trust in California. Thus, a business trust, also frequently called a Massachusetts trust, can only be created in states with a scheme for creating a business trust entity.

When created (in another state), business trusts can neither operate in California nor buy, sell, lease or operate real estate located in California on behalf of the entity or anyone else without first qualifying as a corporation under the California Corporate Securities Act. Business trusts are foreign corporations. [Calif. Corporations Code §§170; 171]

As foreign corporations, business trusts must register with the Department of Corporations and file corporate income tax returns with the Franchise Tax Board (FTB), since they will be conducting business within the state by owning and operating real estate assets. [Corp C §191; Calif. Revenue and Taxation Code §23038(b)(2)(B)]

Thus, a business trust, being a foreign corporation once it enters into activities in California, must qualify with a state agency before:

  • conducting any trust business [Fin C §107];
  • accepting money from investors in exchange for share ownership in the trust entity; or
  • conducting any other lawful business in California.

The trustee of a business trust holds title to real estate in his name (as trustee for the named business trust), and controls the operation of the property. The trustee is also a principal himself, and is personally liable for all debts/obligations incurred by the business trust, as though he were a general partner in a limited partnership. [Goldwater v. Oltman (1930) 210 C 408]

Further, the business trust itself is liable for obligations incurred on its behalf in the management of the real estate vested in the trustee. Also, the assets of the business trust are directly liable for any torts of the trustee, such as failure to properly maintain the security of tenants or the condition of the property which causes injury to others. [Alphonzo E. Bell Corporation v. Bell View Oil Syndicate (1941) 46 CA2d 684]

Should the beneficiaries be authorized to exercise ultimate control over the trustee’s ability to buy, sell, refinance, own or operate the property, including the trustee’s selection of successor trustees, the beneficiaries will then be personally liable for the debts incurred by the trustee. Accordingly, the trustee is then not personally liable since he has been reduced in his powers to that of a mere agent acting on behalf of the beneficiaries. Thus, the association between the trustee and the beneficiaries is not that of a business trust at all. It is a principal-agent relationship under a mere management contract. [Bernesen v. Fish (1933) 135 CA 588]

Real estate investment trusts

One trust entity, called a real estate investment trust (REIT), is authorized to be created under California law, but only if it has been:

  • formed as a REIT under the Internal Revenue Code and does business under the code; and
  • qualified by the Department of Corporations. [Corp C §23000]

The beneficiaries who invest in this real estate ownership entity are called shareowners. The shareowners hold transferable shares which are sold publicly. As individuals, the shareowners are not liable for the debts/obligations of the REIT. The REIT is managed by officers called trustees who also are not liable for the debts and obligations of the REIT.