Level 2 Chapter 4: Trusts as an Ownership Vehicle

Question 1

Trust

Answer 1

Legal entity where control of some asset or property is transferred by a grantor (trustor) to a third party (trustee) to be held for the benefit of another (beneficiary).

Question 2

3 Roles of Trust

Answer 2

1. Trustor: The creator of the trust
2. Trustee: The person entrusted to hold and manage the assets
3. Beneficiary: The individual who ultimately receives the benefits or assets of the trust

Question 3

3 Types of Trust

Answer 3

1. Living Trusts
2. Testamentary Trusts
3. Land Trusts

Question 4

Living Trust

Answer 4

A trust established when a trustor is still alive. It is sometimes called an inter vivos trust. The trustor of a living trust can name themselves the trustee and/or beneficiary to control or enjoy the trusts’s assets while they’re still alive. If they do, they’ll need to designate a backup trustee and beneficiary for when they are no longer able to fulfill that role, either due to incapacitation or death.

Question 5

Probate

Answer 5

The court-supervised execution of a will. A living trust is a great estate planning tool because it keeps the properties from having to go to probate

Question 6

Two Types of Living Trusts

Answer 6

1. Revocable
2. Irrevocable

Question 7

Revocable Trusts

Answer 7

Type of living trust. Can be changed by the trustor at any time. Property can relatively easily be added or removed, beneficiaries and trustees can be changed, and the trust can even be dissolved if it is no longer of use.

Sometimes people will use a revocable trust to shield their property from liability or to disguise the true ownership of the property.

Other times, a revocable trust is simply a supplement to a will, able to be changed if the trustor decides to dramatically disinherit an heir for being a scoundrel.

If a trustor wants to sell the property in a revocable trust, they will generally need to remove it from the trust. Real estate in revocable trusts is not disqualified from the capital gains tax exemption or the mortgage interest deduction.
Properties in a revocable trust are still subject to estate tax, though there is one big tax advantage to revocable trusts called a step up.

Essentially, if the trustor sells the property, the difference between what they paid for the property (known as their basis in the property) and what they sold it for is considered a capital gain.

They may be required to pay capital gains tax on some or all of that amount.

When the trustor dies and the beneficiary inherits the property, the current market value becomes the new owner’s basis, essentially erasing all of the capital gain accumulated by the trustor. That could save the beneficiary big time if the property has been held for a long time and appreciated a lot. All revocable trusts become irrevocable trusts on the trustor’s death. Both kinds of trusts keep properties from going into probate.

Question 8

Irrevocable Trusts

Answer 8

Type of living trust. Very few exceptions, once you put your property in an irrevocable trust, you can’t touch it. It’s no longer yours, it’s the trustee’s, and then the beneficiary’s.

Assets held in an irrevocable trust are not subject to estate taxes because they do not belong to the dead person. They belong to the trust. And trusts never die. All revocable trusts become irrevocable trusts on the trustor’s death. Both kinds of trusts keep properties from going into probate. Assets in an irrevocable trust are also protected from the trustor’s creditors and other liabilities, if they have any. However, there are other tax implications to putting things into irrevocable trusts, so don’t just go flinging stuff in there without talking to a professional.

Question 9

Testamentary Trusts

Answer 9

Created by, big surprise, a testament, or will.

A testamentary trust is all set up while the trustor is still alive, usually as part of their will documents, and then springs into being upon their death.

Because this type of trust takes effect upon the passing of the trustor, the trustor will never play the roles of trustee or beneficiary. The trustor’s property is only transferred into the trust posthumously, so it is part of the trustor’s estate at their death.

That means the property must go through probate, and any applicable estate taxes must be paid on it. This can be a real disadvantage for people trying to leave their heirs property: The IRS only takes cold hard cash, so unless there is enough liquid money in the estate to settle up, the trustee could be forced to sell the property to pay the taxes.

Question 10

Land Trusts

Answer 10

Trust in which land is purchased to be held for a long period of time for the benefit of a named party. A trustor transfers title of a property to a trustee, and names themself the beneficiary. The beneficiary advises the trustee in the management of the property. This relationship is outlined in a trust agreement or deed. Why use a land trust? Land trusts can be used for all kinds of things, including:

Avoiding probate

Shielding a property from liens or judgments against the trustor

Preventing partition of the land

Avoiding marital co-interest

Buying land anonymously
A famous land trust example is the creation of Disney World.