| POTENTIAL PROBLEMS OF A LAND TRUST
With the settlor contributing his own property to the trust for his own benefit, the land trust is a self-settled trust, and therefore cannot be a spendthrift trust which will ultimately prevent creditors who learn about the existence of the trust's assets from being reached.
But what if the seller of property could be persuaded to transfer it into trust for the benefit of a buyer? Would the fact that the settlor of the trust is not also the beneficiary enable spendthrift provisions to be effective? Or what if the original settlor and beneficiary transferred his beneficial interest in the trust to a third party? This transfer of the beneficial interest could also be out of view of possible creditors.
Perhaps the true worse case scenario is that the deed's recitation that legal and equitable title is vested in the trustee results in the trustee being entitled to keep the property as his own, or pledge the property to his creditors, or the trustee's creditors being permitted to execute on property conveyed to the trustee.
§ 12.034 of the Texas Property Code provides as follows:
Merger
(a) If a settlor transfers both the legal title and all equitable interests in property to the same person or retains both the legal title and all equitable interests in property in himself as both the sole trustee and the sole beneficiary, a trust is not created and the transferee holds the property as his own. . .
(b) Except as provided by Subsection (c) of this section, a trust terminates if the legal title to the trust property and all equitable interests in the trust become united in one person."
Under such circumstances the beneficiaries might argue that not all of the equitable interests were conveyed, in that the right to receive the rents and proceeds, to manage the trust property, and to direct the trustee as to the disposition of the property is an equitable interest. But if the parties have agreed that the only beneficial interest retained by the beneficiary is personalty, then it follows that all of the real interests have been conveyed to the trustee, and the merger provision might be interpreted to vest the property in the trustee. Though this is a possible interpretation of § 12.034, this interpretation does not seem likely, in light of § 101.002 of the Property Code, which provides as follows:
"101.002 Liability of Trust Property
Although trust property is held by the trustee without identifying the trust or its beneficiaries, the trust property is not liable to satisfy the personal obligations of the trustee."
The issues have yet to be addressed by the courts in Texas.
In the case of Spiritas v. Robinowitz, 544 S.W.2d 710, 713-715, (Tex.Civ.App. 1976, writ ref'd, n.r.e.), two parties had entered into a joint venture agreement between "Spiritas, Trustee" and "Robinowitz, Trustee" for the purpose of purchasing land known as the Tucker Tract. In the agreement the joint venturers were designated as trustees so that they could transfer part of their interest to third parties from time to time, yet could limit actual participation in the venture to themselves. The agreement provided that it would be governed by the Texas Uniform Partnership Act and that title to the property would be taken in the name of "Robinowitz, Trustee." Subsequently, title to the Tucker Tract was taken in the name of "Robinowitz, Trustee," and four months later title to a different tract was similarly taken. Robinowitz borrowed the purchase money for the second tract from the bank, securing his promissory note with a first lien on that tract and with a second lien on the Tucker Tract. The court held that no trust concerning the property had been created (1) because article 7425b-7 does not include a partnership agreement where one of the partners takes title to partnership property in his name as "trustee," and (2) because the joint venture agreement, in which "Robinowitz, Trustee" was one of the partners, did not show with certainty an intent to hold the title in trust for the venture, as distinguished from the partnership. The Dallas court then reasoned:
"[The] designation ["Robinowitz, Trustee"] was made because the parties contemplated that Robinowitz would act for the benefit of certain employees to be named later. Since the venture agreement does not state that "Robinowitz, Trustee" was to take title in a capacity of trustee for the joint venture rather than as "Robinowitz, Trustee," one of the partners, we conclude that the agreement does not create an additional trust for the benefit of the venture. On the contrary, the agreement provides that the relationship of the parties is to be governed by the Texas Uniform Partnership Act. We cannot impose a trust where parties have contemplated another relationship. G. Bogert, Trusts & Trustees, Section 45 at 316 (2d ed. 1965). Thus, the use of "trustee" in the deed is merely a description and without legal effect. It is as if title were in Robinowitz individually. . . .We conclude that the Texas Blind Trust Act has no application here, and that article 6132b, Section 10(3) of the Texas Uniform Partnership Act, Tex.Rev.Civ.Stat.Ann. art. 6132b (Vernon 1970) governs. . . "
TAX CONSIDERATIONS
The transfer of the property into a land trust would not constitute a taxable event. No consideration is necessary for the enforceability of the transfer of the real property into the trust. The transfer of the personal property beneficial interest would be subject to federal income taxation, but many of the costs of transferring real estate would be avoided.
For income tax purposes, since all of the proceeds from the operation of the trust property are disbursed to the beneficiaries in the proportion that their interests bear to the whole, no tax should be imposed upon the trust unless it is determined to be an association taxable as a corporation. There are six corporate characteristics considered by the IRS25: (1) presence of associates; (2) an object to carry on business and divide the gains; (3) continuity of life; (4) centralization of management; (5) liability of corporate debts limited to corporate property; and (6) free transferability of interests. It appears that there is no continuity of life given the typical twenty year disposition and disbursement of the sale proceeds requirement in the trust instrument. Limitations on the free transferability of interests could be included in the trust instrument. Since the trustee does not have responsibility for management decisions, and cannot act to dispose of the property absent direction from the beneficiaries, it is not likely that the IRS would find the presence of centralized management. A land trust will not be classified as an association taxable as a corporation unless it has four or more corporate characteristics. So it is important to be mindful of these characteristics when drafting the trust documents. If the trust has many members, centralized management and starts doing business as an entity, it may be treated as a corporation. Outlaw v. U.S., 494 F2d 1376 (1974). (Forty-one member land trust formed for the purchase, development and sale of crops from farm lands considered taxable association under I.R.C. 7701(a)(C)).
For federal income tax purposes, the land trust is treated as though the property is owned by the beneficiary. The trustee of a traditional land trust will not even have to file an information tax return. Instead the income and expenses of the beneficiaries will be reported on their personal IRS Form 1040, Schedule C. But vesting the trustee with additional duties may trigger IRS reporting requirements for the trustee.
For estate and gift tax purposes, the IRS treats a revocable, living trust as if title was still in the name of the settlor, if the settlor is the beneficiary and is still alive.26 There is no gift tax due upon the transfer into a land trust.27
There is no requirement that the trust file for a tax identification number while the settlor is still alive. The IRS does not consider a land trust to be a trust at all, since the trustee has no significant duties with regard to the trust property.28
The trustee may be required to file an information return under 26 C.F.R. Section 1.671-4(b). If the trustee has significant responsibilities of managing the trust, a blank IRS form 1041 return is filed with an attached summary of the income and expenses of all of the trust properties, and the same items are reported on the grantor/beneficiary's federal income tax return. However, the appointment of one of the beneficiaries as a co-trustee with management responsibilities should exempt the trustee from such reporting requirements.29
Individuals who are active in the management of their own rental real estate are permitted to deduct passive losses of up to $25,000 against ordinary income, though the maximum amount is reduced by $1 for every $2 above $100,000 of the taxpayer’s adjusted gross income. The beneficiary of a land trust who is actively involved in management of the trust property may be able to claim such passive losses as depreciation.30
The IRS has ruled that a land trust is not a true trust for tax purposes. Therefore, a beneficial interest in a land trust can be exchanged for other real estate under IRC Section 1031.31
However, this ruling applies only to traditional land trusts, which have not yet been formally recognized in Texas. If the trustee is given additional duties to take the trust out of the Statute of Uses, the IRS may not apply the same rules. Bill Bronchik has suggested that it might be appropriate to step out of the trust by having the trustee deed the trust property to the beneficiary, then affect the tax free exchange, and then transfer the new property back into a land trust.32 A transfer of property into a land trust for one's own benefit does not affect the capital gains exemption rules for a principal residence, nor does it affect the deduction for mortgage interest.33
STATUTE OF USES
The question of whether the land trust will be executed because the trustee has no material duties is governed by the Statute of Uses. The Texas version of the Statute of Uses is found at § 112.035 of the Texas Trust Code:
"112.032 Active and Passive Trusts; Statute of Uses
(a) Except as provided in Subsection (b), title to real property held in trust vests directly in the beneficiary if the trustee has neither a power nor a duty related to the administration of the trust.
(b) The title of a trustee in real property is not divested if the trustee’s title is not merely nominal but is subject to a power or duty in relation to the property."
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