Whether you are already a rental property owner or you are deciding it’s time to jump in, there are a few ways you can purchase and own the property: in your own name as a personal asset, under an LLC, or in a trust.
There are various reasons a rental owner would choose not to have a rental property listed as a personal asset. There are different options available to them depending on their goals. For example, if their main concern is protecting themselves and their other personal assets from liability, then they may choose to purchase the property under an LLC (in addition to purchasing liability insurance). There are definite pros and cons for owning a property as an LLC rather than as a personal asset, as we’ve talked about before.
The biggest downside to holding a rental in an LLC is that there is limited access to financing, and converting a property to an LLC after it is titled in an individual’s name triggers a transfer tax in the District of Columbia equivalent to anywhere from 2.2% to 2.9% of the Assessed Value of the property.
But what about holding an investment property in a trust? Creating a trust for your investment property certainly has benefits, but whether or not it’s better than owning the property as a personal asset depends on your goals.
What is a Trust?
Let’s start by talking about what a trust is. A trust is a legal arrangement where a trustee holds property, be it financial assets (like stocks, bonds or investments accounts) or real property, for a beneficiary. The purpose of creating a trust is generally to protect the owner from certain tax or legal exposure. There are primarily two types of trusts we’ll discuss: revocable and irrevocable living trusts.
Benefits of a Trust
Creating a trust is a good option for your personal property, as it allows transfer of the property to your heirs without the hassle of probate and generally protects heirs from paying estate taxes. While there are fewer benefits for a rental property, there are some.
First and foremost, owning an investment property in a trust provides an additional layer of anonymity. When a property title is transferred to a trust, the name(s) of the owner(s) generally can’t be revealed without a court order. This might deter frivolous lawsuits, as the effort and cost of finding the individual owner(s) often outweighs any potential benefit of the suit. Unfortunately, in the digital age when information regarding deeds, property taxes and more is stored in easily searchable databases online, forming a trust for your investment property won’t likely deter lawsuits as much as it may have in the past.
Owning a rental property in a trust may be the best option in a few other cases, as well. For instance, if you’d like to make it possible to transfer the rental property to heirs upon your death, holding the property in a trust may be the best option. In addition, if there is a larger group of investors in the property, a real estate trust can help to carefully and specifically define ownership interests and relationships among the group. It is also relatively easy to create a revocable trust in the District of Columbia, and a transfer tax is not required.
Benefits of a Revocable Trust
A revocable living trust is a trust in which the grantor, beneficiary and trustee are all the same person and the entity uses the social security number of the person for the purposes of tax reporting.
For example, John Smith would move the title to the John Smith Revocable Trust. John would still have control over the asset and can make all of the managerial and financial decisions about it. While assets aren’t protected from liability simply by placing them in a trust, protection comes in the form of avoiding probate court for the asset when John dies. It can save John’s heirs a lot of money and time in dispensing the asset upon his death, not to mention stress and squabbles between the heirs during the period in probate.
A revocable living trust is an estate planning vehicle to preserve family relationships, save the heirs money, and permit the heirs to have access to the asset immediately upon death. Typically, the wait for getting through probate court is six to twelve months.
In general, with these benefits in mind, the more rental properties you own, the more sense it makes to have them in a revocable trust.
Benefits of an Irrevocable Trust
An irrevocable trust is one where the grantor–let’s call her Mary Brown–turns over the control of the asset to a trust and no longer has any control. Also called a Lifetime Asset Protection Trust, Mary as the grantor cannot be a trustee nor a beneficiary. The trust has its own tax ID for the purposes of taxation and a separate identity from the grantor. Mary has no legal say, cannot force the trustee to do anything and cannot be the beneficiary of anything from the trust.
The primary reasons to put a rental property into an irrevocable trust are to serve as a tool for inheritance and to restrict access to the assets by the beneficiaries. Because there is a trustee for the trust, beneficiaries must go through a trustee, presumably to regulate control of the disbursement of the assets.
Holding assets in an irrevocable trust may also be used as a tool to permit Mary to pass assets to her heirs after her death without the assets counting now as her personal wealth or assets for the purposes of determining Medicare eligibility. As Mary gets older and may need long term health care, qualifying for Medicare could be critical for her quality of life.
Drawbacks of a Trust
Setting up a trust brings with it paperwork and fees for attorneys that you won’t incur if you decide to put the rental property in your personal name. While the fees won’t likely be at the level of creating and maintaining an LLC, they’re still something to consider.
Creating a trust for a rental property in the District of Columbia does require registering the property under the trust name and thus the rental will be subject to rent control unless there are underlying reasons to claim an exemption.
In addition, liability insurance may be more costly for a trust than if the policy were in your individual name (although both trusts and individuals see lower premiums than LLCs).
Finally, it is generally easier to get a mortgage in your own name, rather than as an LLC or an irrevocable trust, because lenders prefer the ability to go after personal assets in the case that you default on the loan.
There are clearly benefits to holding an investment property under a trust, but ultimately, the choice is yours. If you’d like additional guidance for your specific case, we’re happy to help you sort out the details and make the decision that is best for your situation. Contact us at any time to learn more.
Thank you to Scott Sweitzer (attorney and owner of Prime Settlement, a real estate settlement company, and Prime Estate Planning, an estate planning company which helps keep families out of court and out of conflict) for his expertise and input as we developed this article.