Introduction
A living trust (also called an “intervivos trust”) is a specific kind of land trust designed to hold property (primarily real estate) during the life of the trustor in order to avoid probate and reduce estate/inheritance taxes at the time of the trustor’s death. It is to be distinguished from other types of land trusts – for example, a pure anonymity trust that has no probate objectives, or an investor trust that contemplates a transfer of ownership by means of an assignment of beneficial interest (used by investors).
The living trust is a tried and true means of avoiding probate court and, if the trustor is married, skipping a taxable event upon the death of his or her spouse. It can also achieve a certain level of anonymity of property ownership, contributing to asset protection. This author considers living trusts to be an excellent way to achieve a variety of positive results. A living trust should at least be considered as part any middle-class estate plan. It is critical, however, that such trusts be properly drafted so as not to restrict the trustor’s access to and use of trust assets during the trustor’s lifetime.
Creating the Trust
The person creating the trust is called the “trustor” or “grantor.” This is the person who conveys property into the trust. The document that creates the trust is called a trust agreement or declaration of trust.
The trustee is charged with management of the trust. Usually, the trustee is same person as the trustor. All power and authority should remain with the trustor, ie., there should be no powers of direction given to the beneficiaries (a common mistake). It is possible to name co-trustees (eg., husband and wife). A successor trustee is named to succeed the trustee in the event the trustee becomes unable or unwilling to serve.
The stated purpose of the trust is “to hold, preserve, maintain, and distribute the Trust Property for the benefit of the Beneficiaries, including but not limited to payment of expenses for their respective health, education, maintenance, and support as the Trustee, acting in his or her sole discretion, deems reasonable, prudent, and necessary.” Beneficiaries include primary beneficiaries and remainder beneficiaries. The trustor and the trustor’s spouse, if any, are the primary beneficiaries. More often than not, the remainder beneficiaries are the trustor’s children and/or other heirs. In this way, the remainder beneficiaries “inherit” the trust property upon the death of the last surviving parent – but without probate.
Note that the trustor reserves the right to revoke or amend the trust. The terms of the trust are therefore not finally fixed until the trustor dies, at which time the trust becomes irrevocable and the remainder beneficiaries automatically succeed to the trustor’s interest. No deed or probate is required at that time. This results in an enormous saving of time, effort, attorney’s fees, and court costs.
Structure of the Trust
There are two basic living trust structures: a simple living trust designed to avoid probate, suitable for both single persons and couples; and the “AB trust,” designed primarily for married couples to avoid both probate and death taxes.
In the case of the AB trust, when one spouse dies, the trust is divided into two separate trusts. This is done in lieu of leaving property outright to the surviving spouse. When this is done, the surviving spouse has the use and enjoyment of the property for life (subject to certain limitations) but does not technically own it and generally cannot sell or transfer it. The result is that federal estate tax is avoided – ie., the property is taxed only once on its way to the children. The drawback is that the surviving spouse has only limited rights to the trust property. Therefore the AB trust may not be suitable for younger couples (say, under 60) who may want to retain all property rights.
It should be noted that the federal estate tax is currently being phased out, which also affects the merits of creating an AB Trust. There will be no estate tax in 2010. However, it will return in 2011 unless Congress acts to extend current law.
Trust Property
Trust property may include any type of property, whether personal or real, tangible or intangible. Additional property may be transferred into the trust at a later date, after the trust is established. The trust need not assume existing liabilities on trust property in order for the transfer to be effective.
Real property is conveyed by general or special warranty deed, which is usually recorded in the county real property records. The trust agreement, however, is not recorded. It is a private and confidential document. Its terms need not even be disclosed to the remainder beneficiaries.
A “spendthrift clause” should be included that prohibits a beneficiary from assigning his or her interest in the trust to creditors. It is also a good idea to include a provision to the effect that creation of the trust does not invalidate either constitutional or statutory homestead protections available to Trustor in Texas or the homestead tax exemption currently on file for Trustor.
Note that transferring property into trust does not reduce a trustor’s assets for Medicaid purposes. Trust property is still counted by Medicaid as belonging to the trustor.
The Trust Agreement, as well as the deed into the trust, should contain language that preserves (1) homestead protections available to Trustor pursuant to Art. XVI, Sec. 50 of the Texas Constitution and Texas Property Code Chapters 41 and 42; and (2) any homestead tax exemption currently on file for Trustor.
Federal Income Taxes
Since a living trust is a revocable and amendable instrument, one should not procure a tax identification number for the trust or attempt to file separate trust tax returns. Forming the trust should not affect how the trustor currently files his or her income tax return. Consult your tax advisor for details.
Comments on Due-on-Sale Clauses
What exactly is a due-on-sale clause, and does it represent a problem for living trusts? A due-on-sale clause enables a lender, at its election, to accelerate a note in the event the property or any interest in the property is sold or transferred. Note that there is no such thing as Abreaching@ or Aviolating@ a due-on-sale clause. This is an enabling clause that gives the lender the option of acceleration if the lender chooses to do so. Generally speaking, if a transaction involves a title transfer without prior consent of a lender that holds a note and lien on the property, then the risk of acceleration is present if the lender=s deed of trust contains a due-on-sale clause and the lender=s prior consent is not obtained. However, there is an exception in the law for living trusts.
The most common wording of a due-on-sale clause is found in paragraph 18 of the Fannie Mae/Freddie Mac Uniform Deed of Trust:
If all or any part of the Property or any Interest in the Property is sold or transferred (or if Borrower is not a natural person and a beneficial interest in Borrower is sold or transferred) without Lender=s prior written consent, Lender may require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if such exercise is prohibited by Applicable Law.
What is Aapplicable law?@ The relevant statute is the Garn-St. Germain Depository Institutions Act (U.S.C. Title 12, Chapter 13, Sec. 1701j-(d) reads:
. . . a lender may not exercise its option [to accelerate the note] pursuant to a due-on-sale clause upon . . . (8) a transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property.
This is the federal living trust exception, which was intended to create an exception to enforcement of due-on-sale clauses in connection with transfers of property to family trusts designed to avoid probate.
Pour-Over Will
It is good practice for the trustor to execute a last will and testament that contains “pour over” provisions designed to convey into the trust any property that was not previously designated as trust property.
Using an Attorney to Draft and Maintain the Trust
Clients often call and ask for a “standard” trust – or worse, a fill-in-the-blank form – neither of which exists at any acceptable level of quality, and that includes “trust kits” available on the internet. There is no substitute for the analysis and advice of a competent professional in this complex area of the law, especially when it comes to making the trust effective in a state like Texas where there are unique and specific laws relating to homestead property.
The challenge for the attorney is to discover what the client is trying to achieve and then tailor a document to suit specific needs. That does not mean that the client must pay high legal fees. Effective, customized trusts are available from this office for $750 (warranty deed into the trust included) plus the per-page recording fees charged by the county clerk (usually $28). Simple wills in conjunction with the trust are half the usual fee. All fees are subject to change.
It is also useful to have an attorney to assist with changes in trust property or amendments to trust provisions that may occur over the years after the trust is established. Trust maintenance can be as important as trust formation.
The Role of the Title Company
Note that if and when the property is sold out of the trust (usually after the death of the trustor) the title company will probably want to see the trust agreement. Once again, it is important that the trust be properly drafted so a Texas title company will accept it as valid. Otherwise, the title company will likely ignore the trust altogether and require signatures from all persons having an actual or potential interest in the property or, in the alternative, a judicial determination of heirship – either of which can defeat the purpose of creating the trust in the first place.
It is astonishing how many title companies are ignorant of basic trust law and practice. It is occasionally necessary for the trustor’s attorney to discuss the trust with the title company closer or attorney in order to educate him or her as to the nature and effect of the trust. This is another powerful reason to have a knowledgeable attorney working on your behalf. No internet service will do this.
To facilitate a title company’s cooperation, the trust agreement should include release and indemnity language that a title company may rely upon in issuing title insurance. In rare cases, if all of the foregoing measures have been unsuccessful in obtaining a title company’s cooperation, it may be necessary to change title companies.
Attached to this article is a checklist that provides the attorney with necessary basic information to begin drafting the trust.
By: David J. Willis
