To the man with a hammer…

Posted by Matthew McClintock

Everything looks like a nail.

I recently had a conversation with a good friend who is also becoming a client. He was in the process of buying a rental house and he wanted to reduce his liability risk. Rental real estate can be a great source of income, but there are significant risks of lawsuits that can threaten both the rental property and the property owner’s other assets.

We discussed some typical asset protection structures he should consider, including having the property owned by a protective LLC, which is, in turn, owned by a protective irrevocable trust. We discussed why some LLC states are more protective than others, and recommended he use a non-Colorado LLC as the property owner.

When we got to discussing the trust that would own the LLC, he said that he already has a trust, and that he wanted to use that as the LLC owner to “keep things simple.” He – like almost everyone – was under the mistaken impression that a “trust” is just a trust, and that even if styles differ, all trusts accomplish fundamentally the same things.

Nothing could be farther from the truth

The kind of trust my friend has is the same kind of trust lots of people have for basic estate planning purposes: a revocable living trust. A revocable living trust is an excellent basic planning alternative and is far superior to a will. It provides for efficient transition of control if an individual becomes disabled due to illness or incapacity, and can avoid probate proceedings if the individual dies. It allows a controlled, intentional distribution of property after death, and can provide significant inheritance protection for a surviving spouse, partner, kids, or other loved ones.

But it provides no asset protection for the individual during his or her life. A revocable living trust is primarily a tool that avoids conservatorship or guardianship proceedings if the individual is incapacitated, and it avoids probate at death. And frankly, everyone should have this kind of trust.

Different tools do different things

The trust I proposed to my friend is a very different kind of tool. It’s the kind of trust established in a much more protective jurisdiction that allows him to put some property aside as a future investment for him and his family, continue to enjoy the property, and insulate the property in the trust from any future creditors. This kind of trust is designed very different than any revocable trust.

First, a protective trust is irrevocable. Once my friend designs the trust according to his wishes, he cannot change the terms of the trust ever again. (There are certainly ways to make sure the trust can adapt as my friend’s needs change; he just can’t hold the power to change the trust after he signs it.) Although this concept might seem scary, it’s a very common feature of many advanced legal planning strategies.

Second, the trust has to be designed to carefully follow the protective laws of the right jurisdiction. In order to get a high level of protection, we have to design the trust under the laws of a state that provides a high level of privacy and that allows protections that my friend’s home state (Colorado) doesn’t provide.

Third, the trust has to be property funded. In this case, the rental house needs to be titled in the name of a protective LLC, and that LLC has to be owned by the protective trust. After all, if the strategy is going to actually work, we can’t stop at the design and document drafting phase; all the paperwork to properly transfer the property into the structure has to get done.

Finally, the trust has to be carefully administered by a trustee in the protective jurisdiction. This means that my friend must have a trustee in our “target jurisdiction” carry out the trust according to the trust’s terms and according to the protective laws of the jurisdiction.

Knowing when to use which tool…

The art in successful legal planning is knowing not only how different trusts – or LLCs, or other structures – solve different problems. Moreover, it’s critically important to understand how some states’ laws offer far more protection and privacy – and in some cases, significant income tax opportunities – than others.

We have built our careers on knowing critical differences between various estate planning tools, understanding which states offer superior protections, and linking them together to create effective estate and asset protection solutions for people.

For someone who really just has a “nail” problem, a typical hammer might do just fine. Most people I meet have more complex problems to solve, so they need more complete and more elegant solutions.

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