The Beauty of Ir­re­vo­ca­ble Trusts

For ul­tra­wealthy clients in the prop­erty busi­ness, an ad­viser’s start­ing point should be an ir­re­vo­ca­ble trust. But you can’t stop there.

Financial Planning - - CONTENT - By Martin M. Shenkman

For ul­tra­wealthy clients who in­vest in real es­tate, an ad­viser’s start­ing point should be an ir­re­vo­ca­ble trust. But you can’t stop there.

A START­ING POINT FOR HIGH-NET-WORTH CLIENTS — es­pe­cially those ex­plor­ing real es­tate in­vest­ments — is to em­pha­size that ir­re­vo­ca­ble trusts are an es­sen­tial part of es­tate plan­ning.

This is not af­fected by the re­cent dis­cus­sion of the pos­si­ble elim­i­na­tion of all fed­eral es­tate taxes. Even if ir­re­vo­ca­ble trusts are no longer cre­ated for tax rea­sons, they should still be cre­ated.

Hav­ing ap­pre­ci­at­ing real es­tate owned by flex­i­ble ir­re­vo­ca­ble trusts gives clients more tax plan­ning op­tions, what­ever the tax laws hap­pen to be. The more flex­i­ble buck­ets in which clients’ as­sets are stored, the more op­por­tu­ni­ties to plan.

Re­gard­less of the po­ten­tial tax ben­e­fits, build­ing wealth in ir­re­vo­ca­ble trusts pro­vides as­sets with pro­tec­tion ben­e­fits from law­suits and claims.

Noth­ing Wash­ing­ton does is likely to re­duce the liti­gious na­ture of our so­ci­ety. Just one ex­am­ple of the pos­si­ble ben­e­fits of ir­re­vo­ca­ble trusts is that they can in­su­late as­sets from the di­vorce claims of heirs.

Be­low are some other de­tails of es­tate plan­ning that are worth con­sid­er­ing for clients with sig­nif­i­cant real es­tate hold­ings:


It has be­come com­mon in modern es­tate plan­ning to have trusts ad­min­is­tered within states that have tax and le­gal en­vi­ron­ments that are fa­vor­able.

Four states — Alaska, Delaware, Ne­vada and South Dakota — have been the lead­ers in the trust game for years, but other states con­tinue to join the fray by en­act­ing more fa­vor­able rules.

There is much at stake. The gen­eral con­cept of “ir­re­vo­ca­ble” in an ir­re­vo­ca­ble trust is that it can­not be changed. In re­cent years, how­ever, the no­tion of merg­ing — or, in es­tate plan­ning par­lance, de­cant­ing — an ex­ist­ing trust into a new trust has be­come more widely ac­cepted.

This can pro­vide a great deal of flex­i­bil­ity to mod­ern­ize ad­min­is­tra­tive pro­vi­sions in an old ir­re­vo­ca­ble trust. But not all states per­mit de­cant­ing.


An even newer con­struct is non­ju­di­cial mod­i­fi­ca­tion. This oc­curs when a liv­ing grantor, all fidu­cia­ries and all ben­e­fi­cia­ries agree to change an ir­re­vo­ca­ble trust. Delaware en­acted a law per­mit­ting this move last year.

This is an in­cred­i­bly ro­bust pro­vi­sion, but only one ex­am­ple of the kind of fa­vor­able laws that Delaware and other

trust-friendly ju­ris­dic­tions can pro­vide.

An­other fa­vor­able op­tion that might have con­sid­er­able im­por­tance for some real es­tate in­vestors is the abil­ity to have a quiet trust. The gen­eral rule in many states is that most adult ben­e­fi­cia­ries (some­times re­ferred to as qual­i­fied ben­e­fi­cia­ries) must re­ceive in­for­ma­tion about the trust. This would typ­i­cally in­clude a copy of the trust doc­u­ment and an­nual re­ports.

If a trust is ad­min­is­tered in a state whose laws per­mit the trus­tee to forgo such com­mu­ni­ca­tions and the trust doc­u­ment pro­vides that no com­mu­ni­ca­tion be given, how­ever, then the ben­e­fi­cia­ries may not have to be in­formed.

For some real es­tate clients, this may be an im­por­tant goal.

If prof­its are to be rein­vested in the prop­er­ties, the client may pre­fer to have a quiet trust so the heirs do not clamor for dis­tri­bu­tions when the money is needed for im­prove­ments or ex­pan­sions.


Many clients use trust-friendly states to min­i­mize state in­come taxes. While this may also be fea­si­ble for real es­tate in­vestors, it is more dif­fi­cult and lim­ited be­cause in­come gen­er­ated by a prop­erty in a par­tic­u­lar state is likely to be taxed in that state no mat­ter where the trust own­ing the prop­erty is lo­cated.

Nev­er­the­less, other types of in­come — such as in­vest­ment earn­ings on cash ac­cu­mu­lated from dis­tri­bu­tions and rein­vested — may avoid state in­come tax­a­tion with this type of plan­ning.


Real es­tate clients should con­sider struc­tur­ing their ir­re­vo­ca­ble trusts as a di­rected trust. This is a trust for which the trus­tee func­tion is bi­fur­cated into at least two parts.

The first role is an in­vest­ment ad­viser or trus­tee, re­spon­si­ble for all in­vest­ment de­ci­sions. Hence, this per­son can de­ter­mine

Many clients use trust­friendly states to min­i­mize state in­come taxes.

whether the trust will hold or sell any real es­tate in­ter­ests.

The sec­ond trus­tee role is as a gen­eral trus­tee, who holds all other trust pow­ers. This can be a cru­cial com­po­nent of the suc­ces­sion plan for an in­vestor with sig­nif­i­cant real es­tate hold­ings. The client her­self can serve as the ini­tial in­vest­ment trus­tee (and this should not af­fect the re­moval of the real es­tate in­ter­ests from her es­tate).

If one child or heir will ul­ti­mately suc­ceed to manag­ing the busi­ness, but all the heirs will be ben­e­fi­cia­ries of the trust, this struc­ture per­mits pass­ing the ba­ton to the des­ig­nated heir to man­age, while leav­ing the trus­tee with the flex­i­bil­ity to al­lo­cate the fi­nan­cial as­sets how­ever de­sired.

To take ad­van­tage of this flex­i­ble struc­ture, the trust will have to be formed in a ju­ris­dic­tion that has laws per­mit­ting di­rected trusts.

Oth­er­wise, the gen­eral trus­tee will have li­a­bil­ity for real es­tate de­ci­sions that they are not ac­tu­ally con­trol­ling.


The com­mon ap­proach to struc­tur­ing real es­tate in­vest­ments is to cre­ate sep­a­rate lim­ited li­a­bil­ity com­pany for each prop­erty.

If com­plex es­tate plan­ning tech­niques will be used to shift some of these in­ter­ests to ir­re­vo­ca­ble trusts, it will of­ten be help­ful to cre­ate a master lim­ited li­a­bil­ity com­pany to own in­ter­ests in the many prop­er­ties and in other LLCS.

This can greatly sim­plify the le­gal doc­u­men­ta­tion and fi­nan­cial trans­ac­tions that are re­quired.

Con­sider the prospect of gift­ing and sell­ing in­ter­ests in 20 dif­fer­ent prop­erty LLCS to a trust, ver­sus form­ing a sin­gle master LLC to own those un­der­ly­ing in­ter­ests so that the trans­fer of just one LLC’S in­ter­ests to the trust are nec­es­sary.

It is of­ten help­ful to cre­ate a master LLC to own in­ter­ests in prop­er­ties and in other LLCS.

Many in­sti­tu­tional trus­tees charge an in­cre­men­tal fee for each lim­ited li­a­bil­ity com­pany in­ter­est they have to hold be­cause of the ad­min­is­tra­tive bur­dens. For most clients, that is not an is­sue.

But for many real es­tate in­vestors, given the ten­dency to use sep­a­rate LLCS for each prop­erty, it can be­come a sig­nif­i­cant an­nual cost. Us­ing a master LLC might be a way to avoid that.


Real es­tate in­ter­ests, even if held in LLC for­mat, will cre­ate a tie to the state where they are lo­cated.

If the client cre­ates a trust in a dif­fer­ent state to own those in­ter­ests, is­sues might arise as a re­sult of the con­nec­tions to the states where the prop­er­ties are lo­cated.

One way to min­i­mize those con­nec­tions might be to cre­ate an lim­ited li­a­bil­ity com­pany in the state where the trust is to be ad­min­is­tered and have that LLC hold the pow­ers of trust in­vest­ment ad­viser and trust pro­tec­tor.

The peo­ple pro­vid­ing this ser­vice would then do so through that LLC, thus pos­si­bly re­duc­ing the trust’s con­nec­tions to the state where prop­erty is ac­tu­ally lo­cated.


Life in­sur­ance is likely to re­main an im­por­tant fea­ture of the es­tate plan for ma­jor real es­tate in­vestors. Hav­ing per­ma­nent life in­sur­ance cov­er­age to pro­vide liq­uid­ity may be in­valu­able to avoid a forced sale of prop­er­ties dur­ing a mar­ket down­turn. Some type of tax is likely to be due.

Us­ing in­sur­ance to de­fray some por­tion of that tax (whether cap­i­tal gains or es­tate tax) can be vi­tal to the suc­ces­sion of the real es­tate busi­ness.

When plan­ning that in­sur­ance, ad­vis­ers should con­sider us­ing ir­re­vo­ca­ble trusts that are flex­i­ble enough to hold real es­tate LLC in­ter­ests and life in­sur­ance.

Hav­ing both real es­tate and in­sur­ance in the same trust can en­able dis­tri­bu­tions from real es­tate prop­er­ties to be used to fund in­sur­ance pre­mi­ums, avoid­ing the need to deal with an­nual gifts and the req­ui­site notices (Crum­mey pow­ers) tra­di­tion­ally used with such gifts.

Tak­ing this ac­tion might re­quire the ap­point­ment of a sep­a­rate trus­tee for in­sur­ance mat­ters.


Suc­ces­sion plan­ning is a vi­tal is­sue to ad­dress for clients with ex­ten­sive real es­tate hold­ings. Ad­vis­ers should make sure that the at­tor­neys in­volved are co­or­di­nat­ing both the pro­vi­sions and plan­ning in the gov­ern­ing en­tity doc­u­ments and the trust and es­tate plan­ning. In many cases, this work is han­dled by dif­fer­ent lawyers, and if it is not co­or­di­nated, costly prob­lems can re­sult.

The doc­u­ment used to file a pro­fes­sional LLC in Ne­vada.

Hav­ing per­ma­nent life in­sur­ance cov­er­age to pro­vide liq­uid­ity may be in­valu­able.

Martin M. Shenkman, CPA, PFS, JD, is a Fi­nan­cial Plan­ning con­tribut­ing writer and an es­tate plan­ner in Fort Lee, New Jersey. He runs laweasy. com, a free le­gal web­site.

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