Trusts and Business Organizations: Key Concepts and Regulations
Trusts
A trust is a device where one person (trustor) transfers ownership of property to another (trustee) to hold or manage for the benefit of a third party (beneficiary).
Example: A parent (trustor) transfers money to a trust account (held by a bank as trustee) to pay for a child's (beneficiary) college tuition.
Parties Involved:
- Trustor: The person who creates the trust.
- Beneficiary: The person who benefits from the trust.
- Trustee: Holds legal title to the property and carries out the trust's instructions.
The trustee acts as a fiduciary, meaning they act in confidence and have a special legal relationship with the beneficiary.
The trustee's powers are limited by the terms of the trust agreement.
A trust can be established during the trustor's lifetime or through a will.
Real estate can be held in trust in many states.
The trustor, trustee, and beneficiary can be people or legal entities (corporations).
Trust companies or corporations can be set up for the purpose of acting as trustees.
Trusts are often used in wills, especially by wealthy individuals, to manage the distribution of assets to children or other beneficiaries.
Example: Instead of giving a 21-year-old millions of dollars, a trust can distribute funds in stages (e.g., at age 23, at age 30, and the rest at age 40).
Trust terms can include conditions for receiving funds (e.g., marriage).
Living Trusts vs. Testamentary Trusts (Wills)
Property owners may establish a trust for their own financial care or that of their family.
Living Trust: Created by agreement during the property owner's lifetime.
Testamentary Trust: Established by a will after the owner's death.
These trusts determine what happens to assets after death.
The trustor conveys property to a trustee (often a corporate trustee) with the understanding that the trustee will manage the assets to produce income.
The income is used to pay for trust operating expenses, trustee fees, and the benefit of the beneficiary.
Trusts may continue for the beneficiary's lifetime, or assets may be distributed when the beneficiary reaches a certain age or meets other conditions.
Living trusts have become a major estate planning tool to minimize the time and cost of probate.
In a living trust, the property owner (trustor/grantor/settler) transfers ownership of real property to a trustee, who is often the same person as the trustor.
The owner continues to control the assets of the trust.
Upon the death of the trustee, the property passes to the beneficiaries without the need for probate (court involvement).
In community property states, spouses may transfer property into a trust and name themselves as joint trustees with right of survivorship.
Right of Survivorship: Upon the death of one spouse, the property automatically transfers to the surviving spouse without court intervention.
Land Trusts
Real estate is the only asset of a land trust.
The property is conveyed to a trustee, and the beneficial interest belongs to the beneficiary.
The beneficiary is often also the trustor.
While the beneficial interest is personal property, the beneficiary retains management and control of the real property.
The beneficiary has the right of possession and the right to any income produced by the property or proceeds from its sale.
Land trusts are frequently created for conservation purposes (farmland, forests, wildlife habitats, coastal land, scenic vistas).
Key Characteristic: Public records usually do not name the beneficiary.
Land trusts may be used for secrecy when assembling separate parcels of land.
The beneficial interest can be transferred by assignment, making deeds unnecessary.
The beneficial interest can be pledged as security for a loan without recording the mortgage.
Because the beneficiary's interest is personal property, it passes at the beneficiary's death under the laws of their state of residence, potentially avoiding additional probate costs and inheritance taxes if property is owned in multiple states.
Land trusts ordinarily continue for a definite term (e.g., 20 years).
If the beneficiary does not extend the trust term, the trustee is obligated to sell the real estate and return the net proceeds to the beneficiary.
Examples of Land Trust Use:
- James Rouse (Columbia, Maryland): He used land trusts to acquire land secretly to create the planned community of Columbia.
- Walt Disney (Disneyland): He acquired land secretly to build Disneyland.
Ownership of Real Estate by Business Organizations
A business organization is a legal entity that exists independently of its members.
Ownership by a business organization makes it possible for many people to hold an interest in the same real estate.
Partnership
A partnership is an association of two or more people who carry on a business for profit as co-owners.
General Partnership: All partners participate in the operation and management of the business and share full liability for business losses and obligations.
Limited Partnership: Consists of one or more general partners (who run the business) and limited partners (who are not legally permitted to participate in management).
Limited partners are liable for business losses only to the amount they invested.
Example: Investing in a real estate project allows participation in profits without management responsibilities.
General partners are the major investors who make the decisions.
Corporations
A corporation is a legal entity (artificial person) created under the laws of a state.
Managed by a board of directors, selected by the owners (shareholders).
The board of directors selects the officers (president, treasurer, secretary) who are responsible for the day-to-day operations.
The corporate charter sets forth the powers of the corporation, including the ability to buy and sell real estate.
A corporation can own real estate in severalty (one owner) or as a tenant in common with other people or corporations.
The corporation continues to exist until formally dissolved, and the death of an officer or director does not affect the title to the property.
The president of a corporation issues orders and has worker bees to do the work.
A corporation involved in real estate needs a licensed real estate agent to handle transactions.
Limited Liability Company (LLC)
A relatively recent form of business organization combining features of limited partnerships and corporations.
Members of an LLC enjoy the limited liability offered by a corporation.
LLCs offer the tax advantage of a partnership because income flows directly to the members and is not subject to double taxation (as with corporations).
Corporations are taxed when they receive income and again when they distribute dividends to shareholders.
LLCs are taxed only once.
Condominiums
Condominium laws are often called horizontal property acts and have been enacted in every state.
The owner of each unit in a condominium holds a fee simple title to that unit.
Individual unit owners also own a specified share of the undivided interest in the remainder of the building and land (common elements).
Common Elements: Land, courtyard, lobbies, exterior structure, hallways, elevators, stairways, roof, and recreational facilities.
Limited Common Elements: Balconies and patios used exclusively by individual unit owners.
Owners own the common elements as tenants in common.
Condominium unit owners do not have the same right to partition that other tenants in common have.
Condominium ownership is not restricted to high-rise buildings; it can include low-rises, townhouses, and detached structures.
Each unit becomes a separate parcel of real estate owned in fee simple and may be held by one or more persons in any type of ownership recognized by state law.
A condominium unit may be mortgaged like any other real estate.
The unit can be sold or transferred to whomever the owner chooses unless the condo association provides for a first right of refusal.
Real estate taxes are assessed and collected on each unit as an individual property.
An owner's default will not affect the other unit owners.
The condominium property is administered by a Homeowners Association (HOA), governed by a board of directors, and managed by a property manager.
The HOA adopts rules regarding the operation and use of the property.
The HOA is responsible for the maintenance, repair, cleaning, and sanitation of the common elements.
The HOA must also maintain fire extended coverage and liability insurance.
The expenses of maintaining and operating the condominium building are paid by the unit owners in the form of fees and assessments.
Recurring fees (HOA fees) are paid monthly, quarterly, semiannually, or annually, depending on the bylaws.
If fees are not paid, the association can seek a court order judgment and have the delinquent owner's unit sold or place a lien on the property.
Assessments are special payments required of unit owners to address specific expenses like a new roof.
Cooperative Ownership
In a cooperative, a corporation holds title to the land and building.
The corporation offers shares of stock to prospective tenants.
The price a corporation sets for each apartment becomes the price of the stock.
The buyer becomes a shareholder in the corporation and receives a proprietary lease to the apartment for the life of the corporation.
Cooperative tenant owners do not own real estate; instead, they own an interest in a corporation.
The operation and management of a cooperative are determined by the corporation's bylaws.
Shareholders of the corporation control the property and its operations.
An important issue is the method by which shares in the corporation may be transferred to new owners.
The bylaws may require that the board of directors approve any new shareholder.
The burden of any defaulted payment in a cooperative falls on the remaining shareholders.
The approval of prospective tenants includes a financial evaluation because each shareholder is affected by the financial ability of the other.
If the corporation is unable to make mortgage and tax payments because of shareholder default, the property might be sold by court order and foreclosure suit.
The IRS treats ownership of a cooperative the same way it does a fee simple interest in a single-family home or condominium regarding deducting loan interest and property taxes and the home sellers tax exclusions.
Timeshare
Timeshare ownership permits multiple buyers to buy relatively small interests in real estate (typically resort properties).
Each buyer receives the right to occupy the facility for a certain period.
Timeshare Estate: Includes a real property interest in a specified unit for a particular period of the year.
The owner can sell, give away, or will the timeshare estate.
Timeshare Use: A contract right under which the developer owns the real estate.
The owner of the timeshare use has the right to occupy the facilities for the designated period each year, but only for a certain number of years.
At the end of that time, the ownership rights and the property terminate.
A timeshare use is equivalent to a license.
Maryland Condominium Act and Timeshare Regulations
A condominium is subject to a plan of organization called a regime and is governed by a council of unit owners.
The condominium regime must be registered with the Secretary of the State of Maryland before condominium units can be sold or offered for sale.
A contract for the initial sale of a residential condominium unit to a member of the general public is not enforceable by the seller until the buyer is given a copy of the public offering statement registered with the Secretary of State.
Buyers can make a written rescission of a purchase contract without stating any reason within fifteen days of receiving the public offering statement and are entitled to a prompt return of their money.
Before a rental, residential rental facility can be converted to condominium ownership, tenants must be given notice in the form prescribed by law, also registered with the Secretary of State.
Tenants must be given at least 180 days' notice before being required to vacate the premises, except for breach of lease.
A contract for the resale of a unit by a unit owner other than a developer is not enforceable unless that contract contains a conspicuous type notice in the form specified by the condominium act.
The unit owner is required to furnish four things to the buyer no fewer than fifteen days before closing
These must include the condo documents
Resale property buyers have seven days to cancel a contract of purchase after receiving the documents
A developer who desires to convert a building more than five years old into a timeshare project is required to include an engineering report in a public offering statement and give the tenants 120 days' notice that they must move because they are converting the building
First-time home buyers, brand new timeshares, have the right to cancel a sales contract up until midnight of the tenth calendar date following the day that they received all the documents.
Buyers must receive documents fifteen days before closing and if it is resold have seven days to cancel contracts