Keeping the Faith: Fiduciary Duties – Forming LLCs to Hold Real Property
by Brian L. Shetler
November 01, 2005
Trustees of irrevocable trusts have the unenviable task of deciding how to invest for the benefit of others under the California Uniform Prudent Investor Act (UPIA). If they make the right decisions, they receive no added benefits—they are just fulfilling their duties. However, if they make the wrong decisions, they have to account to the beneficiaries.
Because of this, many trustees understandably favor liquidating assets that involve hands-on management, such as real property. Often real estate is sold immediately upon a trust becoming irrevocable, and the proceeds are invested in stocks and bonds. After all, it is hard to fault a trustee who invests in a diversified portfolio of stocks and bonds. In addition, liquidating real property reduces the risk of environmental liability for the trust and eliminates the risk of losses to a trust from trips, slips, and falls by eggshell plaintiffs trying to become the newest beneficiaries of the trust assets. Claims relating to a small piece of real property in a trust can swallow not only the equity in the real property, but also the other assets of the trust.
However, under the UPIA, selling all the real estate is not always the right decision. Trustees must weigh the factors specified in the UPIA under the particular circumstances that they face. The key factors in this consideration are laid out in Probate Code § 16047(c)(1)-(8), including the ambiguous catchall eighth factor: “an asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries.” Even if all other factors favor liquidating property in a trust, this eighth factor can be an overriding one.
Whatever the circumstances, however, any trustees who are determining whether to retain real property in an irrevocable trust should consider placing that real property in an entity. Forming a limited partnership with a limited liability company as the general partner (both wholly owned by the trust) or simply forming a single-member limited liability company to hold title will minimize the risks associated with any real estate holding. Each property would be in its own separate entity with its own separate insurance.
If a claim arising out of the property is made following the transfer of the property to an entity, then claimants will have a hard time proving anything but the assets of the entity alone are liable for such claims. The result is that the decision to retain the real property as an asset of the trust would no longer expose so much of the trust assets to claims arising out of the real property.
Generally, there are no adverse tax consequences from forming an entity wholly owned by the trust. For income tax purposes, a single-member limited liability company is disregarded, and a limited partnership is pass-through. For property tax purposes, there are no reassessments; although, the trust’s distribution provisions should be considered to avoid transfers of more than 50 percent of an entity.
In addition, even if the trustees decide to sell the real property, they may want to first place the property in an entity. Trusts with banks as trustees do not need to pay the newly imposed 3 percent FTB withholding on the sale of real property, but trusts with individuals as trustees do not have the same exemption.
Therefore, for the sake of the trust (and the trustees), consider holding any real property in a limited liability entity.
Brian Shetler, Berliner Cohen partner, focuses his practice on trusts and estates, tax and other estate administration issues. He works with corporate fiduciaries as well as families and individuals in establishing and carrying out plans to preserve and build legacies for generations. For more information, please contact Brian Shetler at firstname.lastname@example.org.
©2008 Berliner Cohen. This article is not intended to and does not constitute legal advice or a solicitation for the formation of an attorney-client relationship and no attorney-client relationship is created through your use of the Berliner Site or your receipt of the materials. Attorneys in the Berliner Cohen Probate & Trust Administration Group will be pleased to provide further information regarding the matters discussed in this article.