REAL ESTATE INVESTMENT: LLC vs. Land Trust
As an attorney, I sometimes end up suggesting a course of action I know is not the best solution in order to stay within the client’s comfort zone. It’s a bit frustrating, actually, but I understand where the client is coming from. There are significant sums of money at stake, and clients rightly want to understand the proposed structure.
Last week, we discussed 10 advantages of a land trust [a Florida land trust, to be specific]. The purpose of that article was to make people aware of the possibilities with a land trust, which truly is a very useful vehicle.
Experience has taught me, however, clients who are unfamiliar with trusts will almost invariably decide in favor of an LLC no matter how much I extol the virtues of a land trust. When it comes down to it, clients would rather go with an inferior solution they can understand than something that sounds exotic or too good to be true.
That is fair enough. However, when viewed side-by-side with the familiar LLC, I think you will find a land trust is not such an exotic creature after all.
Some of the problem may simply be the nomenclature. Perhaps juxtaposing equivalent terms will provide a better understanding of — and greater comfort level with — land trusts, at least in the context of real estate investment.
Limited Liability Company (LLC) vs. Florida Land Trust
LLC – OWNER/MEMBER
The person who puts in the time and start up capital to launch a limited liability company is usually referred to as the “member” or “managing member.” Owners will often use additional titles such as “president” or “CEO” because they are more commonly recognizable. There is a technical difference, which we will get into a bit below. For now, the point is that limited liability companies have “owners.”
Land Trust – GRANTOR
To keep things simple, we will say the grantor of a trust is equivalent to the owner of an LLC. There is such a thing as a non-grantor trust, which is a technique used for asset protection. However, for a simple land trust, the grantor is the one who sets up the trust, just as the owner sets up an LLC.
There is actually a difference between grantors and owners that is worth mentioning. The owner of an LLC hopes to make a profit for himself. A grantor can do the same thing with a trust, and often does during his lifetime. However, a trust is set up for the benefit of the “beneficiary(s).” And, typically, the beneficiary(s) of the trust is someone other than the grantor–such as the grantor’s children or wife, for example.
So, one common set up is where the grantor takes the profit/proceeds generated by the trust during his lifetime and, after the grantor dies, the assets of the trust go to the beneficiaries. In this way, there is an added estate planning feature to the land trust that you do not get with an LLC.
LLC – OPERATING AGREEMENT
This is the document that contains the company bylaws. Along with the Articles of Organization, this is the LLC’s governing document. There should be provisions about decision-making authority, election of officers, dissolution of the company, etc.
The operating agreement can stipulate who should be named president of the company when the owner dies. So, it is possible to do a bit of succession planning with an operating agreement. In my opinion, there is a limit to how far you can go with the operating agreement, though, because it just gets weird.
Nobody (i.e. a judge) expects to see a bunch of estate planning provisions in the company’s operating agreement. So, while there is nothing preventing one from including provisions about healthcare, custodial duties, rights of the owner’s heirs, etc., it is uncertain whether those provisions would be enforced by a court. After all, an operating agreement is a business document. It is not a will.
Trust – TRUST AGREEMENT
The trust agreement is the document that governs the trust. It has provisions similar to those of an operating agreement regarding management of the trust’s affairs. Additionally, trusts are typically used for estate planning, so you can readily include provisions regarding heirs, healthcare, funeral arrangements, guardianship, and other things you would normally expect to see in a will. There will not be anything weird about estate planning provisions in a trust document, and you can be sure a judge would indeed enforce those provisions. So, you can get double-duty out of a trust agreement in a way that would not be advisable with an operating agreement.
LLC – PRESIDENT/CEO
Entities cannot speak for themselves or sign documents, so they have to be represented by one or more human beings. For this reason, a president and/or other corporate officers are named to act on the company’s behalf. Often, the president is the owner of the company, but that is not necessarily the case. The president could simply be an employee who has no ownership interest.
Trust – TRUSTEE
Like the president of a company, the trustee acts as the representative of the trust. Sometimes, the grantor will act as the trustee. In that case, the trustee is for all practical purposes the “owner” of the trust. However, there are often situations where the grantor would not want to be the trustee.
If asset protection is a concern, then the grantor would appoint someone else to be the trustee. Or, if the grantor lives far away, it may greatly simplify things to have a local person act as trustee. Also, if the grantor wants the transition to be smooth when he/she dies, then using someone else as trustee – or naming a successor trustee – is an excellent solution.
You can name anyone you want as a trustee, but there are some very good reasons to make it an attorney, accountant, or trust company, rather than a friend or family member. That is a topic for a different article, though.
LLC – EMPLOYEES & CONTRACTORS
Obviously, these are the workers who carry out the company’s business activities.
Trust – EMPLOYEES & CONTRACTORS
A trust can also employ workers though, frankly, that would not be common for a land trust. Usually, the trust would hire outside companies or contractors to manage properties, provide maintenance and repairs, invest trust funds, etc.
LLC – PARTNERS
Naturally, you can have more than one owner — i.e. partners — and divide the ownership interests equally or unequally.
While it is common for partners, which are called “members” of the LLC, to have different percentages of interest in the company, it would not be common to stipulate to much more than that. In other words, you can delegate decision-making authority in the operating agreement, and you can divide ownership interest. But, you cannot go much further than that.
Trust – BENEFICIARIES
The beneficial interest apportioned to the beneficiaries of a trust is similar to ownership interest divided among partners in an LLC. You do, however, have much more control over beneficial interest. You can name as many beneficiaries — and their successors — as you want, and you have complete control over
- how much they receive
- how they receive it
- when they receive it
- what conditions must be met
- who you want to act as custodian, in the case of beneficiaries who are minors
- skipping generations
That is probably far enough for now. In other articles, we explore tax implications, the use of professional trustees, and other nuances. For now, the purpose is to understand some of the inner workings of a land trust and realize (i) it is not so entirely different from an LLC, and (ii) it is pretty much all upside with a trust.
The only real downside to a land trust is the time spent trying to explain it to clients. ; )