Do Land Trusts Equal Asset Protection?
I am often asked whether or not land trusts provide any asset protection benefits to individuals who establish them. Typically, this type of trust is used to hide the identity of the person (“settlor”) who creates this trust. The land trust is irrevocable and therefore cannot be changed. I will discuss below a very recent 9th Circuit case that ruled the land trust provided no protection at all against the IRS. The 9th Circuit case is important for Californians because this is our federal appeals court and its decisions are controlling.
I recently asked a group of tax and estate attorneys about what their feelings were about land trusts and whether or not they provide any asset protection to the settlor. The over whelming response was that land trusts provide no asset protection benefits and generally are used for estate planning purposes.
The possible exception to this would be in states like Alaska, Delaware and Nevada that provide by their statutes some type of asset protection for “self settled trusts” and the assets are located in one of those particular states.California does not have these kinds of statutory provisions to protect the settlor. It is very questionable if any California court would rule against California’s state policies to protect its citizens from an out of state land trust that has different statutory state polices.
Townley Case.
As I mentioned above, the 9th Circuit ruled that an irrevocable trust afforded a Washington couple no asset protection even against a creditor that was not at the time but rather a future creditor. Although the case originated in the state of Washington it will have far reaching impact in the 9th Circuit.
Facts:
The Townleys had owned their personal residence since 1977. In 1990, the couple borrowed against the equity in their personal residence to purchase an interest in investment property. In 1995, the Townleys created the Beaver Valley Trust and conveyed both their personal residence and their interest in the investment property into this new trust.
Although the Beaver Valley Trust has an independent trustee and their children were the beneficiaries, the Townleys were named the "Trust Managers" for an indefinite period and given the power to handle all trust affairs. The Townleys continued to live in their personal residence, but did not pay any rent to the trust or even make the utility payments.
By 2000, the Townleys had gotten themselves into tax trouble and had been assessed nearly $175,000 in unpaid taxes, interest and penalties. In 2001, the Townleys filed for bankruptcy to attempt to avoid their personal federal tax liability. Although the Townleys' objection to the IRS's claim was denied, the Townleys were given a discharge and the bankruptcy trustee reported that there was no unsecured property available for distribution.
The IRS then filed suit in U.S. District Court to reduce the federal tax assessments to judgment, set aside the transfers to the Beaver Valley Trust as fraudulent, and to foreclose on the federal tax liens.
The Townleys claimed that they did not make the transfers to defraud the IRS, since the IRS was not even their creditor at the time they created and funded the trust. They argued that they created and transferred property into the Beaver Valley trust to protect their assets from unknown future creditors.
District Court Ruling:
Townley testified that he was concerned about potential "lawsuits from the exposure we had from liability from troubled boys in the State of Washington." The District Court held that since the Townleys transferred their property to the Beaver Valley Trust before the IRS became a creditor, the IRS would be considered a future creditor of the Townleys under Washington law.
But, far from exculpating the Townleys from a fraudulent transfer, the District Court held that their admission that they made the transfers to protect against unknown future creditors was a veritable confession of their actual intent to hinder, delay or defraud all creditors, including the IRS.
The District Court then noted that, in addition to satisfying the actual intent test, the Badges of Fraud that constructively prove the Townleys' intent to defraud creditors were also satisfied by their admissions:
The court found other factors that indicated that the transfers were fraudulent.
The Townleys
- • retained possession and control of their personal residence by continuing to live in it after the ostensible transfer.
- • did not make any rent payments.
- • did not pay the utilities.
- • transferred substantially all of their assets to the trusts (so they had no means of paying their tax (or other) bills as they came due).
- • received no consideration for the transfer of their properties when they gifted them to the trusts.
9th Circuit: In a short memorandum opinion, the 9th Circuit affirmed:
"The district court did not err in holding that the Townleys transferred their real property into the Beaver Valley Trust in violation of the Washington Uniform Fraudulent Transfers Act. The Townleys' repeated admissions that they transferred property to the Trust in order to avoid potential future creditors provide direct evidence of fraud. Further, by demonstrating that the property transfer was characterized by multiple badges of fraud, the government also showed compelling circumstantial evidence of fraud. Therefore, the government provided the requisite 'clear and satisfactory proof' that the Townleys possessed an 'actual intent to hinder, delay or defraud a creditor' under the UFTA."
Conclusion.
The Townley case is a very good example of what not to do. Land trusts generally will not afford you asset protection if you are the settlor of that trust, even if the trust is properly maintained. However, if there is a proper business purpose for the trust (e.g. estate planning) it can provide some protection to non settlor beneficiaries. Land trusts are not the “silver bullet” that can do all things for every situation as claimed by their promoters.