Real estate investors often spend decades building a portfolio they want preserved for future generations. When creating a revocable living trust, they may be tempted to prohibit the trustee from selling, refinancing, or changing how those properties are managed. In this episode of Trust This, Attorney Joe Seagle explains why retaining control through permanent restrictions may ultimately work against the beneficiaries the trust was designed to protect.
A trustee may need flexibility to address tax considerations, property management responsibilities, changing real estate markets, eminent domain proceedings, or an unusually favorable purchase offer. The person chosen as trustee may also lack the time, experience, or desire to manage rental properties. If the trust imposes rigid requirements, the trustee’s hands may be tied when selling or diversifying the assets could better protect the trust’s value.
A strong estate plan should preserve the creator’s intentions while allowing the trustee to respond responsibly to circumstances that cannot be predicted today. Carefully drafted discretion may help the trustee manage risk, evaluate opportunities, and pursue the best available outcome for the beneficiaries. Watch the full episode of Trust This to learn why giving your trustee appropriate flexibility could strengthen your real estate legacy.
Transcript
I have a lot of clients who come to me and they always want me to put in their trust agreements, their revocable living trust agreements, restrictions on what their trustee can do with the real estate after they’re gone.
Restrictions in there that the trustee is not allowed to sell the real estate, that they have to refinance it if it, if the debt gets down to a certain amount, that they have to do this, they have to do that, they have to maintain it.
And I’m always having to tell the client that that’s really not the smartest thing in the world.
While real estate may have been your business while you were alive or while you were capable, that may not be your beneficiary’s desire.
There’s a couple reasons that you want to be able to allow that trustee to have a lot of discretion with the real estate. And number one is a tax reason.
Because let’s say you die and your trust becomes irrevocable. At that point, all of that real estate, the value of it steps up, the basis steps up.
So if you bought that property at $100,000 and it’s now worth a million dollars, that is $900,000 worth of gain. If you had sold that property during your life, you would have had to pay tax on the $900,000 of gain.
But if your trustee can sell that property immediately or soon after your death, that is $900,000 of income that is not going to be taxed, at a capital gains tax for your heirs.
So that’s an, that’s one big, big reason you want to give your trustee the discretion to do with the property what they feel they need to do.
Another thing is, is the trustee may have, if it’s, if it’s somebody in your family, one of the children or a, relative, they may have other jobs that they may have another career that they do, and they don’t have time to manage the property like you did.
So saddling them with this property to manage as the trustee and saying, and if you sell it, you have violated the terms of the trust, which subjects them to civil liability to a lawsuit is a bad thing.
So you need to give them that discretion that if they need to sell the property, they need to sell the property.
Also, what happens if the state comes along and says, hey, we’re going, take this property by eminent domain and, or you can just sell it to us and we’ll take, and we’ll give you cash for it, or you, we’re going to make you go through a lawsuit.
And the trustee goes, I’m not allowed to sell it. You’re going to have to sue us to take it by eminent domain. That’s the only thing we can do, because my hands are tied as trustee.
So that’s not very fair.
Another one is, what if somebody comes along, a developer, and you maybe have a single family home sitting on the beach, and a developer comes along and says, hey, we want to build a condo tower here or an apartment complex or a hotel on this property, and they offer you just to offer the trustee just a stupid amount of money.
And the trustee goes, sorry, I’m not allowed to sell the property because my hands are tied by the terms of the trust. I’m never allowed to sell this property.
All we have to do, all we’re ever allowed to do is rent it out as a personal home, one single family residence.
So if you have these restrictions, you tie your trustee’s hands, especially when it comes to real estate.
Those are just some of the examples I can think of off the top of my head that you don’t want to do that.
So before you get in your head, when you’re putting together your estate planning trust, your estate plan for the future after you’re gone, or even if you just become incapacitated and your trustee has to take over.
Before you do that, and before you put those same handcuffs on your trustee that you’ve put on yourself, you need to think twice about it, because it can actually end up costing your estate a lot of problems.
It can cost your estate a lot of money. It could cause your beneficiaries to not, get the full value of what you’ve left them, whereas a trust, and also one more thing, a corporate trustee.
So if you’ve got an independent corporate trustee who’s named, they may just refuse to be trustee because there’s a lot of real estate.
And they. Most corporate trustees don’t enjoy managing real estate. They prefer to liquidate it, throw the money in the market, and stocks and bonds and private equity and hedge funds and all these other places where the money just goes, and it sits and they’re not having to manage real estate.
And I’ll, just tell you, corporate trustees don’t like to manage real estate as part of an estate plan trust because they are required by law to get a certain return on the investment every single year for the beneficiaries.
And if there’s a market crash, a real estate crash, and they couldn’t diversify because you tied their hands, they couldn’t diversify the funds, and now they are personally liable to make up the difference for those beneficiaries.
By law they have to put their own money into the trust to make up for maybe a crash in real estate values or maybe, the property was taken and the value that came out of the property wasn’t enough to keep the value up for the, the beneficiaries for that year for the return on their investment.
So the trustee has to, has this danger of having to put their own skin into this game to keep the beneficiaries from having a right to sue them for failing to return the investment that the, and that they are entitled to by law.
So this is just yet another reason to keep in mind.
Yes, you may be a real estate investor, yes, you may love all your real estate and you’ve, you’ve done a very good job making a living, off of the rental income coming in.
But that may not be the same path or the best path for your trustee to be shackled to that. They can never take a different path.
So I just urge you that if that is in your head as real estate investor and you are looking at, leaving a lot of real estate inside your revocable living trust, especially if it’s layered inside of LLCs, inside of land trusts like we typically advise people to do, I would urge you to reconsider that.
Let your trustee have that discretion that if they need to sell the properties, they can sell the properties and they may actually in the long run end up maximizing a return on investment for your next generations that you were unable to do while you were alive simply because you would only be able to 1031 exchange into other properties to defer the capital gains and the depreciation, recapture taxes or they, you, you also have to, you know, pay commissions and, and closing costs and things that maybe the trustee, whenever they sell it, they can negotiate better deals and in the long run maximize the value of that real estate for your, your beneficiaries in a way that you’re just simply unable to while you’re alive.
So want to put that out there?
If you’ve ever got any questions, let us know. If you have any comments on this, please leave us a comment below. We love to get your comments on these things.
And otherwise, until later, just trust this.
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