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For Newbies

Naming Successor Trustee: Estate Planning for Real Estate Investors

Naming Successor Trustee: Estate Planning for Real Estate Investors

Today, we are going to tackle a serious topic: management of the investment properties in your portfolio after your passing.

This is also known as estate planning and it also concerns decisions about your portfolio until you expire, so don’t discard it right away – it’s more than simply jotting down a will.

Will vs Trust

What’s written in a will is, more or less, a done deal, and probate courts serve to ensure that the grantor’s wealth is passed to the rightful heirs. On the other hand, while trusts allow successor trustee to manage assets if the grantor is incapacitated or dead, if you are the trustee of your own trust, you can make changes at any time.

Before we proceed ahead though, let’s explain all the fiduciary terms.

Trustee – the person who manages the assets on behalf of the beneficiaries. There can be more than one trustee (for example, spouses that act like co-trustees), and the grantor themselves can serve as trustee while they are still alive.

Successor trustee – the person who has a responsibility to take over the management of the assets when the primary trustee is no longer able to. There is usually a list of successor trustee names (suppose, all of the siblings in a family), but if the successor trustee is not able or willing to manage the assets, they can pass the responsibility to the next in line, or they can hire a professional (trust management company).

Grantor – or trustor, the person who holds the assets, i.e. the one who creates the trust.

Beneficiary – the person (or persons) who will eventually receive the assets from the trust. Typical example of beneficiaries are under age children, but it can be an adult person as well (one that isn’t savvy in real estate and investments) or other heirs.

Different Types of Trusts

In essence, trust is an entity created for processing estate transfer instruments. It resembles a will, because it details how to manage the assets after the death of the grantor. However, when it comes to defining the responsibilities of the trustee, this legal entity can outline different models. As a result, we have two types of trusts, revocable and irrevocable trust, so let’s see the differences between the two. 

Revocable Living Trust

Revocable living trust allows you to transfer the deeds to properties in your portfolio in the trust. So, if you are both the grantor and the trustee, you can practically do whatever you please with the assets, without the need for intervention by courts.

Let’s see why this is important.

Trusts Eliminate Courts From the Equation

Suppose a real estate investor has a will but they are not able to manage the assets (either incapacitated or dead). Now, these are all grim scenarios, but we must consider them.

If the real estate investor expires, then their property goes to probate court. The probate proceedings can literally take years to grant rights to heirs. No matter how well thought out your will is (distribution of assets, duties and responsibilities, access to vital financial data), the beneficiaries won’t receives any of that, until a court allows them to.

If the real estate investor is incapacitated (illness or accident), their assets go into conservatorship – a guardian of property is appointed by a judge and this guardian makes decisions about asset management. To regain control of the wealth, you need to go to court and challenge this (in a nutshell, to prove that you are capable of taking over).

Revocable living trust enables you (the trustee) to simply pass on trust management to the successor trustee. No need to go to court: the successor trustee whose name is after yours on the list takes over. It can be a family member, venture partner or trust management company, but they’ll have access to your investment portfolio immediately. Often successor trustees already act in a capacity similar to that of the trustee anyway (for instance senior venture partner is trustee, and junior venture partner is successor trustee).

Changing Trusts Provisions

The “revocable” part doesn’t hurt, too. You can make decisions (i.e. sell a property), change trust provisions, and you can even cancel the trust. Revocable living trust is much better than a will in this regard – as long as you are the trustee, you can alter the terms.

Irrevocable Trust

As the name applies, irrevocable trusts don’t allow flexibility. Once you set the terms of the irrevocable trust, you can’t change them, regardless how badly you need access to the wealth.

The main benefit to irrevocable trusts is in terms of the process to establish them: it doesn’t take too much time and effort to set them up.  

We’ll check out the process for creating a trust below, but first let’s take a look at some other options.

Alternatives To Trusts (And Why They Don’t Work)

There are two alternatives to trusts and wills: co-ownership and beneficiary deed.

Co-ownership

This one’s pretty straightforward – you own the property, but you add the beneficiary as your co-owner. You just need to change the title of the property and that’s it. The surviving co-owner will get the property without involvement of the courts.

The drawbacks of co-ownership are particularly bad for real estate investors. Co-owners have the right to decide what happens to the property. So, if you need to sell the property, the co-owner has to consent. It’s like the veto power in politics, and most real estate investors don’t like to grant this power to anyone.

Beneficiary Deed

Beneficiary deeds are similar to co-ownership, however, with this option, the beneficiary is stripped of the power to influence your decision. The process works along the following lines: you add the beneficiary to the deed of the property with a note that the beneficiary can assume ownership after your death.

You are also eliminating the court system with these solutions. The transfer of ownership (once you pass over) is a simpler procedure, but this option might not be available for all real estate investors – either because there are no laws in your state about it, or because the type of property can’t hold a beneficiary deed.  

Establishing Revocable Living Trust

Although the process to establish revocable trust might seem simple, the reality is that it can become a very complex task. The trust agreement is a legal document and you can quickly put one together, especially with the help of lawyers.

But then you need to decide which of the assets will go to each beneficiary. And, don’t forget, this is a trust, so you have to appoint a trustee that will act on behalf of the beneficiaries. You might end up with a handful of beneficiaries each with their own trustee that will handle assets.

Even if you have one beneficiary and one trustee (yourself, or the grantor) you still need to consider a list of successor trustee names. It’s like the line of succession to the throne in European royal families – it’s best to add provisions that determine who will manage the real estate investing business and the properties that remain behind you.

At the end you need to specify: who the trustees are, who the successor trustees are, and the order in which each of them needs to act. Sometimes the responsibility is shared between more than one successor trustee.  

Re-titling Assets

Once the legal document is written and you make a list of successor trustee names, all other property documentation should reflect the trust terms. You will need to change the titles on all properties that are to be handled by the trustee. This is often a long and costly process.

Hiring a Professional vs Authorizing a Family Member

Since the process of setting up a revocable living trust can be time consuming, some real estate investors hire professional trust management agencies. Opinions vary as to whether this is a good idea.  

The Benefits of Using a Professional Fiduciary Agency

Professional trust managers will know the ins and outs of estate planning. They are up to date with laws and regulation, and they can offer their advice about administrative duties, insurance, and taxation. This is crucial because if the trustee doesn’t comply with regulation (even if the trustee didn’t knew such regulation existed), some of the rights can be taken from them.

The Drawbacks of Using a Professional Fiduciary Agency

At the same time, fiduciaries are motivated to manage someone else’s trust because of the compensation they’ll receive. It’s not unusual for professional trust managers to charge high fees for their service. Trustees aren’t always willing to pay these fees for something they can ultimately do by themselves.

Plus, real estate investing is a niche business and finding someone who knows both investment and real estate might be an issue. Professional trust managers usually handle assets like equity, stocks, and other investments, and they might struggle with recreating what real estate entrepreneurs do.

The Benefits of Naming a Family Member as a Trustee

A family member is more likely to have the best interest of everyone within the family at heart. It’s not always so, but chances are, they’d be willing to put an extra effort to take care of their

little brother or sister or their aging parent.

Also, family comes to mind naturally when you make the list of successor trustees. You can slowly initiate them into the business be their your spouse or your kids. If, god forbid, something gruesome does happen, they’ll be able to step up right away.

The Drawbacks of Naming a Family Member as a Trustee

The primary risk of naming family members as successor trustees is them not being up to the task, for whatever reason. Maybe they’ve done a job that’s completely different than real estate investing, and it’s too big of a shift to make. Or they can’t handle the entrepreneur lifestyle, including mood swings (anxiety and adrenaline rush, both typical for real estate investors).

Aside from that, estate planing can stir up heated discussions between family members. Relationships may suffer from it, regardless of the grantors will to settle property inheritance issues once and for all. The effect of greed on people can’t be neutralized through a legal document. And if a family member is a trustee, it makes matters much worse because it’s easy to point fingers at the asset manager.

The Cons of Revocable Living Trusts

We already discussed the biggest pet peeve about revocable trusts – it requires changes of the legal title of all properties in the trust. You can’t get around that. There are other potential issues with revocable trusts you should also be aware of.

When you set up a trust, this doesn’t affect taxation. You still need to cover due taxes. Same applies to duties you have for other assets and accounts. For instance, if you grow your retirement nest egg in an IRA, you can’t include the account in the trust. This, and other tax deferred accounts, can’t be addressed through a trust.

And if you bank on short deadlines for enacting estate transfer instruments, don’t. Yes, a revocable trust will allow trustees to skip probate proceedings, but if some of the heirs want to contest the grantors will, they can. This will slow the whole process down (depending on the regulation, up to three months).

Takeaway

As much as estate planning is hard to do, it’s a step that every real estate investor with considerable assets should take. In a way, you make sure your close ones are taken care of when you’re gone.

Many options are at your disposal: the standard will, revocable and irrevocable trusts, beneficiary deed, and co-ownership. Out of all these, revocable living trust offer the greatest degree of flexibility, while also helping you skip probate courts and potential conservatorship.

Some of you have handled motivated seller leads for houses in probate and you know what the process entails. The proceedings can drag for years, meanwhile accumulating costs and fees, and in the end your intended beneficiary might not even receive the estate.

Let the scare of probate motivate you to set up a revocable trust. Assign beneficiaries (and their trustees) to your properties. And don’t forget to name several successor trustees – just to make sure that the estate will end up where you intended to.

 

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