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Do Land Trusts Provide Asset Protection?

Have you heard that land trusts provide asset protection? Do you believe it?

Applicable Law

Two cases from Illinois concluded that, in a land trust, although the legal and equitable title lies with the trustee, most of the usual attributes of real property ownership are retained by the beneficiary under the trust agreement: (1) Just Pants v. Bank of Ravenswood, 136 Ill.App.3d 543, 483 N.E.2d 331, 335-36 (Ill.App. 1985); and (2) People v. Chicago Title and Trust Co., 75 Ill. 479, 389 N.E.2d 540 (Ill. 1979).

Just Pants v. Bank of Ravenswood

In Just Pants v. Bank of Ravenswood, 136 Ill.App.3d 543, 483 N.E.2d 331, 335-36 (Ill.App 1985), the lessee of property which was subsequently sold under a land trust sued the trustee of the land trust for conversion and breach of contract. Following judgment in favor of the trust, the trial court granted the lessee’s motion to amend the complaint and judgment to include the beneficiaries, and entered judgment against only the beneficiaries. The beneficiaries appealed, and the Illinois Court of Appeals held that reversal was required where the reviewing court had no way of knowing the respective responsibilities of the trustee and the beneficiaries. 483 N.E.2d at 333-34. The Court noted that, in an action involving a land trust, the question of whether the beneficiary or the trustee is the proper party depended upon the nature of the action in light of the rights and duties established by the trust agreement. The Court pointed out that the beneficiary in a land trust is the proper party to litigation involving his rights and liabilities of management, control, use and possession of the property; and, moreover, that beneficiaries in land trusts oftentimes retain managerial rights in the property, and in exercising these rights, enter into a variety of contractual arrangements resulting in the accrual of causes of action against then that do not involve the trustee. The Court observed that actions sounding in tort involving land trust property usually arise from the operation and maintenance of the property; that such causes are based on negligence, and accrue against only the beneficiary, and not the trustee; and that the trustee is insulated from these responsibilities if he has no rights of possession, operation, control, or maintenance. Thus, the Court concluded that trustees who hold legal title to realty through a trust agreement are not liable for damages resulting from defects in the trust premises when the agreement gives the beneficiaries, and not the trustees, the power to make the needed repairs; and furthermore, that beneficiaries can also be held responsible for the torts or frauds of the trustee where they participate in or authorize the commission of the wrongs. 483 N.E.2d at 335. The Court remanded the case to the trial court to determine the respective responsibilities of the trustee and the beneficiary under the trust agreement. 483 N.E.2d at 336.

People v. Chicago Title and Trust Co.

In People v. Chicago Title and Trust Co., 75 Ill. 479, 389 N.E.2d 540, 542-43, 546 (Ill. 1979), a consolidation of six separate actions brought in the name of the People of the State of Illinois to recover unpaid real estate taxes on land held in land trusts, the State sought to impose personal liability for the real estate taxes on the following three entities: (1) the banks or trust companies in their individual corporate capacities; (2) the banks or trust companies in their capacities as land trustees of land trust property; and (3) the beneficiaries of the land trust, all as “owners” of the tracts of land trust property. The trial court found the trustees in their individual corporate capacities liable, and dismissed the cases as to the banks and trust companies as trustees, and as to the beneficiaries. 389 N.E.2d at 542. The Illinois Supreme Court granted motions for direct appeal, and held that, since the beneficiaries of a land trust controlled the purchase, sale, rental, management, and all other aspects of land ownership and title; and since the trustees could act only upon the beneficiaries’ written direction, the beneficiaries were “owners,” within the meaning and intendment of the statute providing that “owners” of realty shall be liable for taxes. As such, the beneficiaries were personally liable for the unpaid real estate taxes. The Court stated that the realities of land ownership clearly indicated that land trust beneficiaries were “owners”; and that, as “owners,” they were personally liable for the unpaid real estate taxes. 389 N.E.2d at 546.

In so concluding, the Court reviewed the history of the Illinois land trust. The Court noted that the Illinois land trust was a unique creation of the Illinois bar, although its acceptance elsewhere had received a great deal of attention. The Court pointed out that its origin was rooted in case law rather than in statute; and that, over the years, the land trust had served as a useful vehicle in real estate transactions for maintaining the secrecy of ownership and allowing for the ease of transfer. The Court noted that, despite recent disclosure statutes, the Illinois land trust remained a widely utilized and useful device. 389 N.E.2d at 543. The Court emphasized that, in land trusts, the legal and equitable title lies with the trustee, and the beneficiary retains what is referred to as a personal property interest; however, most of the usual attributes of real property ownership are retained by the beneficiary under the trust agreement. In fact, the Court observed that the only attribute of ownership ascribed to the trustee is that relating to title, upon which third parties may rely in in transactions where title to the real estate is of primary importance. 389 N.E.2d at 543.

Conclusion

The prevailing belief, that land trusts protect property owners from all liability, is not even true in Illinois, which originated land trusts.

New Rules for HELOCs

Your Home is No Longer a Full Service Tax Deducting ATM

Have you ever tapped the equity in your home to pay for a new car or a college tuition? With a HELOC, also known as a home equity loan or line of credit, you could do so. Better yet, you could deduct the interest you paid on those loans on your tax return.

The new tax law has changed all of this (at least through 2025, when this portion of the tax law expires). With over 14 million HELOCs borrowing over $500 billion, the new rules affect many Americans for the tax year starting 2018.

You can still tap into your home’s equity for whatever you want. But under the new tax law, you can’t deduct the interest in every circumstance. And there are limits on how much you can deduct even if you are using the money correctly.

What is a proper usage for an interest deduction?

Borrowings used to “buy, build or substantially improve” your home are accepted. Fast cars are not. (But again, you can still buy the car and just not deduct the interest.)

The borrowing must be used to improve the house securing the loan. So you can’t use a HELOC on your primary residence to improve a vacation home.

Interest can only be deducted on the total debt of up to $750,000 for up to two homes. If you had a debt of up to $1 million on one or two homes before December 15, 2017 (the last date before the tax law changed) you can still deduct the interest if the money was used to improve, build or buy a home.

How does the $750,000 limit come into play?

Let’s say John has a $700,000 mortgage on a primary residence and borrows $100,000 on a HELOC to make improvements on that property. His total borrowings are now $800,000. John can only deduct interest on the first $50,000 of the HELOC. The remaining $50,000 in interest is over the $750,000 limit.

Mary has a primary residence and a vacation home. Her residence has a $300,000 mortgage on it with the vacation home having a $200,000 mortgage. Her total borrowings are $500,000. Mary then borrows $100,000 against each property. The money borrowed against her primary residence goes for improvements on that property. Likewise, the $100,000 vacation home borrowing is used for a landscaping project on that property. Mary’s total borrowings are now $700,000. Because she used the money the right way on each property she can deduct the full amount of interest on the $700,000 in loans.

There is another wrinkle to be aware of here. You can only deduct interest on a HELOC of up to $100,000. And that HELOC deduction is limited to the price you paid for the property.

Let’s say you bought a Detroit fixer-upper for $50,000. Somehow, you are able to get a HELOC on it for $75,000 so you can completely remodel it. You can only deduct interest on the first $50,000 of the loan, because that is what you paid for the place.

Once again, the tax law benefits single persons. Two singles could deduct a combined $1.5 million in mortgage debt ($750,000 each) if they bought a home together. Married couples are limited to the $750,000 amount.

Of course, record keeping becomes important in this arena. You’ve got to be able to prove all of this up to the IRS. Track your spending and save all of your invoices. If you don’t already have one, consider using a bookkeeper to assist with it. Save these records for a good long time. The IRS may take years to get at any audits on this. You may need to be prepared into the distant future.

Does Asset Protection Trump the US Constitution?

An Alaska Supreme Court Rules on Alaska Domestic Asset Protection Trusts Created to Protect Assets from a Montana Lawsuit

Court Case: Toni 1 Trust, by Tangwall v. Wacker 2018 WL 1125033

For fraudulent conveyances,

Can one state assert exclusive jurisdiction over another?
Does asset protection trump the U.S. Constitution?

Several years ago Alaska put forth a legislatively strong asset protection statute. It was modeled after the popular asset protection trusts found in the Cook Islands and similarly small Caribbean island nations. These offshore trusts allowed you to both be the grantor (the person setting up the trust) and the beneficiary (the one benefitting from the trust.) Self settled trusts weren’t allowed in old England, the birthplace of common law. They were bad form. You can’t set up your own trust to protect your own assets was the guiding rationale. A ‘self-settled trust’ was akin to cheating. But Britain’s island dependencies needed an industry besides tourism. And the rich needed an island to park their money.

The foreign asset protection trusts became so popular that a number of U.S. states considered them. Alaska was first. Delaware, Nevada and 13 other states followed with their own domestic asset protection trusts (DAPT.) After a holding period where transfers into a DAPT could be challenged (Nevada’s is two years) the trust can’t be breeched or pierced.

Or can it?

In the Toni 1 case (decided on March 2, 2018) the Alaska Supreme Court had to take a hard look at their asset protection scheme. During a Montana lawsuit the Tangwalls transferred Montana real estate to an Alaska DAPT. A Montana court found the transfer was fraudulent under Montana law. (You can’t put assets out of reach once you have been sued or even threatened with litigation.)

Tangwall sought relief in the Alaska court arguing that only Alaska courts had jurisdiction over an Alaska DAPT. But when the transfer of Montana property was involved the Alaska Supreme Court under the full faith and credit clause of the U.S. Constitution could not limit Montana’s jurisdiction.

A full discussion of the case is below. The takeaway, however, is that asset protection-as we’ve noted before-is an ever changing area of the law.

Issue

What are the potential impacts of the recent Alaska Supreme Court decision in Toni 1 Trust, by Tangwall v. Wacker 2018 WL 1125033 (Alaska, March 2, 2018), on asset protection trusts?

Applicable Law

Alaska Statue 34.40.110(k) (the “Alaska statue”), which purports to grant Alaska courts exclusive jurisdiction over fraudulent transfer claims against Alaska self-settled spendthrift trusts, cannot unilaterally deprive other state and federal courts of jurisdiction.

The Facts of Toni

After a Montana state court issued a series of judgments against Donald Tangwall and his family, the family members transferred two pieces of property to the “Toni 1 Trust,” a trust allegedly created under Alaska law. A Montana state court and an Alaska bankruptcy court found that the transfers were made to avoid the judgments and were, therefore, fraudulent. Tangwall, the trustee of the Trust, then filed suit in the Alaska state court, arguing that Alaska state courts have exclusive jurisdiction over such fraudulent transfer actions under the Alaska statute. However, the Alaska Supreme Court concluded that this statute could not unilaterally deprive other state and federal courts of jurisdiction, and the Court affirmed the Alaska state court’s judgment dismissing Tangwall’s complaint.

More specifically, in 2007 Donald Tangwall sued William and Barbara Wacker in Montana state court. The Wackers counterclaimed against Tangwall; his wife, Barbara Tangwall; his mother-in-law, Margaret “Toni” Bertran; and several trusts and businesses owned or run by the family. In the ensuring years, several default judgments were entered against Tangwall and his family. In 2010, before the last of these judgments was issued, Bertran and Barbara Tangwall transferred parcels of real property to an Alaska trust called the “Toni 1 Trust” (the Trust). The Wackers filed a fraudulent transfer action under Montana law in Montana state court, alleging that the transfers were made to avoid the judgments. Default judgments in the fraudulent transfer action were entered against Barbara Tangwall, the Toni 1 Trust, and Bertran. After the fraudulent transfer judgments were issued, the Wackers purchased Barbara Tangwall’s interest in one of the parcels at a sheriff’s sale, as part satisfaction of their judgment against Tangwall and family. But before they could purchase the remaining half interest, Bertran filed for Chapter 7 bankruptcy in Alaska. Her interest in the trust property was therefore subject to the jurisdiction of a federal bankruptcy court. In December 2012, Donald Tangwall, as trustee of the Trust, filed a complaint in the bankruptcy court against the Wackers and bankruptcy trustee Larry Compton. Among other things, Tangwall alleged that service on the Trust in the Montana fraudulent transfer action was defective, rendering the judgment against the Trust void. Rather than litigate whether service in Montana was proper, Compton elected to bring a fraudulent transfer claim against Tangwall under the federal bankruptcy fraudulent transfer statute. A default judgment in Compton’s action was entered against Tangwall, who appealed from this judgment of dismissed.

Tangwall next sought relief in Alaska state court, where he filed the complaint that led to his later appeal. The crux of his argument was that the Alaska statute granted courts exclusive jurisdiction over any fraudulent transfer actions against the Trust. Specifically, he argued that the Trust contained a provision restricting the transfer of the beneficiary’s interest, and that the Alaska statute granted Alaska courts “exclusive jurisdiction over an action brought under a cause of action or claim for relief that is based on a transfer of property to a trust” containing such transfer restrictions. On this basis, Tangwall sought a declaratory judgment stating that all judgments against the Trust from other jurisdictions were void and that no future actions could be maintained against the Trust because the statute of limitations had run. The superior court dismissed the complaint, and Tangwall appealed. Most of Tangwall’s arguments on appeal were supported by little or no citation to relevant legal authority and were, therefore, waived. However, he preserved his argument that the state and federal judgments against the Trust were void for lack of subject matter jurisdiction under the Alaska statute.

The Decision in Toni

A. Under the Full Faith and Credit Clause, an Alaska statute cannot prevent Montana courts from applying Montana fraudulent transfer law.

The Alaska Supreme Court concluded that the Alaska statute, AS.40.110(k), which purported to grant Alaska courts exclusive jurisdiction over fraudulent transfer claims against Alaska self-settled spendthrift trusts, could not limit the scope of a Montana court’s jurisdiction over a fraudulent transfer action against a trust allegedly created under Alaska law, and thus, a fraudulent transfer judgment entered against a trust in a Montana court was not void for lack of subject matter jurisdiction. The Alaska Supreme Court noted that fraudulent transfer actions were transitory actions, and the Full Faith and Credit Clause did not compel states to follow another state’s statute claiming exclusive jurisdiction over actions and purporting to deprive other states of jurisdiction over all fraudulent transfer actions concerning Alaska trusts, even if the actions arose under other states’ laws.

B. The Bankruptcy Court’s judgment was based upon a cause of action arising under federal law, and states cannot restrict federal jurisdiction; furthermore, a federal statute specifically grants federal courts jurisdiction over fraudulent transfer claims. 

Likewise, the Alaska Supreme Court concluded that the Alaska statue could not limit the scope of a federal bankruptcy court’s jurisdiction over fraudulent transfer claims against the trustee of a trust allegedly created under Alaska law, and this a fraudulent transfer judgment entered against a trustee in bankruptcy court was not void for lack of subject matter jurisdiction. In addition, the Court noted that the Alaska statue was preempted by the Federal fraudulent conveyance statute, 11 U.S.C. § 548(a)(1)(A), which permits trustees to avoid fraudulent transfers.

The Rationale of Toni

A. The Alaska statute, AK 34.40.110(k), cannot limit the scope of other states’ jurisdiction.

Initially, the Alaska Supreme Court recognized that the Alaska statute, AK 34.40.110(k), purported to grant Alaska courts exclusive jurisdiction over fraudulent transfer claims against Alaska self-settled spendthrift trusts. The Alaska Supreme Court stated that, “having reviewed the legislative history of AS 34.4.0110(k), we have no doubt the Alaska legislature’s purpose in enacting that statute was to prevent other state and federal courts from exercising subject matter jurisdiction over fraudulent transfer actions against such trusts.”

The Alaska Supreme Court noted that, more than 100 years ago, the United States Supreme Court held in St. Louis, Iron Mountain & S. Ry. Co. v. Taylor, 210 U.S. 281, 285, 28 S. Ct. 616, 52 L.Ed. 1061 (1908), that each state may, subject to the restrictions of the Federal Constitution, determine the limits of the jurisdiction of its courts, the character of the controversies which shall be heard in them, and, specifically, how far it will, having jurisdiction of the parties, entertain in its courts transitory actions where the cause of action has arisen outside its borders. The Alaska Supreme Court further noted that, just a few years later, the United States Supreme Court held in Tenn. Coal, Iron, & R.R. Co. v. George, 233 U.S. 354, 360, 34 S.Ct.587, 58 L.Ed.997(1914), that states are not constitutionally compelled to acquiesce to sister states’ attempts to circumscribe their jurisdiction over such actions.

In Tennessee Coal, an employee sued his employer in a Georgia court, relying on an Alabama statutory cause of action. His employer countered that Alabama state courts retained exclusive jurisdiction over the suit under the Alabama Code, and that the Full Faith and Credit Clause compelled Georgia courts to respect Alabama’s assertion of exclusive jurisdiction. The United States Supreme Court found the “Full Faith and Credit” does not require states to go quite so far. Instead, jurisdiction is to be determined by the law of the court’s creation, and cannot be defeated by the extraterritorial operation of a statute of another state, even though it created the right of action.

After discussing the facts of Tennessee Coal, the Alaska Supreme Court concluded that the Alaska statute crossed the limit recognized by Tennessee Coal by purporting to grant Alaska courts exclusive jurisdiction over a type of transitory action against Alaska trusts. Acknowledging that the analogy was imperfect, the Alaska Supreme Court held, nevertheless, that Tennessee Coal controlled. The Alaska Supreme Court pointed out that the Tennessee Coal court held that the Full Faith and Credit Clause did not compel states to follow another state’s statute claiming exclusive jurisdiction over suits based on a cause of action even though the other state created the right of action. The Alaska Supreme Court stated that the clear implication was that the constitutional argument rejected in Tennessee Coal would be even less compelling were a state to assert exclusive jurisdiction over suits based on a cause of action it did not create. Applying this rationale to the facts of Toni, the Alaska Supreme Court observed that, in seeking to void the Montana court’s judgment for lack of jurisdiction, Tangwall effectively was arguing that the Alaska statute could deprive Montana courts of jurisdiction over cases arising under Montana law. The Alaska Supreme Court rejected Tangwall’s argument and stated that it was a more extreme interpretation of the “full faith and credit” principle than the interpretation considered and rejected by the United States Supreme Court in Tennessee Coal.

Finally, the Alaska Supreme Court noted that the basic principle articulated in Tennessee Coal had not changed in the last century, and concluded, therefore, that the Alaska statue’s assertion of exclusive jurisdiction did not render a fraudulent transfer judgment against an Alaska trust from a Montana court void for lack of subject matter jurisdiction.

B. The Alaska statue, AK 34.40.110(k), cannot limit the scope of a federal court’s jurisdiction.

Similarly, the Alaska Supreme Court denied Tangwall relief from the federal judgment. The Alaska Supreme Court noted that, while Tennessee Coal addressed only a state’s ability to restrict the jurisdiction of its sister states, the more recent United States Supreme Court decision in Marshall v. Marshall, 547 U.S. 293, 314, 126 S.Ct. 1735, 164 L.Ed 480 (2006), had confirmed that the Tennessee Coal rule also applied to claims of exclusive jurisdiction asserted against federal courts.

In Marshall, the United States Supreme Court considered whether Texas probate courts could retain exclusive jurisdiction over a transitory tort arising under Texas law. Relying on Tennessee Coal, the court concluded that they could not, and that state efforts to limit federal jurisdiction were invalid, even though the state created the right of action giving rise to the suit.

Acknowledging that the analogy was imperfect, the Alaska Supreme Court held, nevertheless, that just as Tennessee Coal should control whether the Alaska statute could restrict state court jurisdiction, Marshall should control whether the Alaska statute could restrict federal court jurisdiction. The Alaska Supreme Court concluded that, just as a state could restrict federal jurisdiction, even though the state created the right of action, a state also could not restrict federal jurisdiction over suits based on a cause of action it did not create. In addition, the Alaska Supreme Court pointed out that, if the Alaska statute were interpreted to deny parties access to the federal courts without those courts’ consent, then the statute might well run afoul of the Supremacy Clause, which ultimately precludes state courts from limiting federal jurisdiction.

Observations by the Alaska Supreme Court in Toni

A. Observations on related state court decisions.

In reaching its decision in Toni, the Alaska Supreme Court acknowledged that the Alaska legislature’s attempt to grant Alaska courts exclusive jurisdiction over a class of claims in some circumstances was hardly unique, and that several other sister states had concluded that similar statutes do, in fact, restrict their jurisdiction. See, e.g., Carbone v. Nxegen Holdings, Inc., 2013 WL 5781103, at *4-5 (Conn. Super,. Oct. 3, 2013); Wilson v. Celestial Greetings, Inc., 896 S.W.2d 759, 761-62 (Mo.App.1995); State ex rel. U.S. Fid. & Guar. Co v. Mehan, 581 S.2d 897, 840 (Mo.App. 1979); Foti v. W. Sizzlin Corp., 2004 WL 2848398, at *1-2 (Va.Cir., Feb. 6, 2004).

The Alaska Supreme Court noted that those courts relied on reasoning that was not applicable to the Alaska statute. For example, the Alaska Supreme Court pointed out that some state courts had applied state-law distinctions between local and transitory action to make discretionary decisions whether to stay or dismiss an action in favor of another forum. However, the Alaska Supreme Court observed that Tennessee Coal had established that a state cannot create a transitory cause of action and at the same time destroy the right to sue on that transitory cause of action in any court having jurisdiction, which suggested that states are not barred from asserting exclusive jurisdiction when the cause of action is local rather than transitory; that the Alaska statute granted Alaska courts exclusive jurisdiction over fraudulent transfer actions against Alaska trusts; and that fraudulent transfer actions were transitory actions.

In addition, the Alaska Supreme Court pointed out that other state courts had declined to hear cases on the basis of an exclusive jurisdiction provision without addressing the Tennessee Coal rule. For example, in Foti, supra, a Virginia Circuit Court elected to respect an assertion of exclusive jurisdiction because “comity suggests that limitations one state’s legislature places on its own laws be universally acknowledged.” However, the Alaska Supreme Court noted that comity is not a legal rule; rather it is a principle under which the courts of one state give effect to the laws of another state out of deference or respect. In other words, while courts may elect to follow a statute like the Alaska statute out of comity, they are not compelled to do so. Furthermore, the Alaska Supreme Court pointed out that the Alaska statute is more than a limitation Alaska’s legislature placed on its own laws; instead, it purports to deprive other states of jurisdiction over all fraudulent transfer actions concerning Alaska trusts, even those based on causes of action arising under that state’s own law.

Finally, the Alaska Supreme Court noted that in IMO Daniel Kloiber Dynasty Trust, 98 A.3d. 924 (Del.Ch.2014), the Delaware Court of Chancery had concluded that Delaware could not unilaterally preclude a sister state from hearing claims under that state’s law, citing Tennessee Coal.

B. Observations on similar related court decisions.

In reaching its decision in Toni, the Alaska Supreme Court noted that several federal courts had concluded that state law “exclusive jurisdiction” provisions did, in fact, deprive them of jurisdiction. See, e.g., Lynch v. Basinger, 2012 WL 6213781, at *5(D.N.J.,Dec. 12, 2012); Yale S. Corp v. Eclipse Servs., Inc., 2010 WL 2854687, at *3-4 (ND.Okla., July 19, 2010); Reserve Sols., Inc. v. Vernaglia, 438 F.Supp.2d 280, 288-89 (S.D.N.Y 2006). However, the Alaska Supreme Court pointed out that only one of these cases was reported, and that none of them addressed either Marshall or Tennessee Coal. Furthermore, the Alaska Supreme Court pointed out that other federal courts had reached the opposite conclusion. See, e.g., Superior Beverage Co. v. Schieffelin & Co., 448 F. 3d 910, 917 (6th Cir. 2006)(“a state may not deprive a federal court of jurisdiction merely by declaring in a statute that it holds exclusive jurisdiction”); Begay v. Kerr-McGee Corp., 682 F.2d 1311, 1315 (9th Cir. 1982) (states “have no power to enlarge or contract the federal jurisdiction”), quoting, Markham v. City of Newport News, 292 F.2d 711, 716 (4th Cir.1961); Duchek v. Jacobi, 646 F.2d 415, 419 (9th Cir. 1981)(same). The Alaska Supreme Court state that the reasoning in these latter cases was both persuasive and consistent with the approach set out in Marshall.

Brief Discussion

The following observations apply to the Alaska Supreme Court’s decision in Toni:

1. To date, sixteen (16) states have enacted asset protection trust legislation, and thirty-four (34) states have not. As such, conflict of law questions may arise concerning the ability of an asset protection trust to protect trust assets from the claims of a trust settlor’s creditors.

2. Toni involved a blatant fraudulent transfer of property to an asset protection trust. The transfers in Toni were made only after most of the default judgments were already entered by the Montana state court.

3. All fifty (50) states, including Alaska, interdict the fraudulent transfer of property. Indeed, Alaska statute AK 34.40.110(b) specifically provides that, “[i]f a trust contains a transfer restriction allowed under (a) of this section [asset protection trusts], the transfer restriction prevents a creditor existing when the trust is created or a person who subsequently becomes a creditor from satisfying a claim out of the beneficiary’s interest in the trust unless the creditor is a creditor of the settlor and…the settlor’s transfer of property in trust was made with the intent to defraud that creditor…”

4. It may be advisable to use a foreign asset protection trust rather than a domestic asset protection trust.

5. Asset protection trust works better when the settlor is a resident in the state with asset protection legislation.

6. Asset protection trust work better when the action is outside of bankruptcy.

7. Asset protection trusts work better when the settlor can avoid personal jurisdiction in a state without asset protection legislation.

8. Asset protection trusts work better when the asset transfer occurs more than ten (10) year limitation period set forth in 11 U.S.C. § 548(e).

9. The federal bankruptcy courts may not always recognize the asset protection features of a state with asset protection legislation, because these assets generally are regarded as property of the bankruptcy estate under 11 U.S.C. § 541.

10. The bankruptcy trustee always is free to commence a fraudulent transfer action under 11 U.S.C. § 548, assuming that the transfer to the asset protection trust occurred within ten (10) years prior to the commencement of the bankruptcy case.

Conclusion

Although states with asset protection legislation may purport to hold exclusive jurisdiction over asset protection trusts, this may not always be true when another state has personal jurisdiction over the debtor. However, as long as the funding of an asset protection trust is not voidable, it does not appear that the decision in Toni damages the usefulness of asset protection planning; rather, the decision in Toni stresses the importance of asset protection planning well before the need for an asset protection trust arises.

Five Steps for Real Estate Asset Protection

When purchasing real estate, it’s critical to protect ourselves and our possessions from lawsuits. We live in the most sue-happy society, in one of the most litigious times, and you need to protect yourself. One way to help prevent people from obtaining all your assets is to take precautions and think ahead, in order to ensure all your life treasures are secure. When a lawsuit is filed against you or your business, all your personal assets like you car, house, equity in your house, and bank accounts are at risk to be taken away. Here are a few ways to help ensure your real estate and personal possessions will be protected and secure.

1. Set Up Your LLC to Hold Your Real Estate

Let’s imagine you are purchasing 4-plex for an investment and will be renting it out for profit. When setting up your entity, make sure it is structured properly to hold the title of the real estate. An excellent entity for real estate is a Limited Liability Company (LLC). When you set up your LLC be sure that is it holding the title of your 4-plex. This structure also helps protect all your personal assets. For example, if a tenant of that 4-plex sues for falling on the property and wins the court case, they are not able to acquire all your personal assets like your bank account, the equity in your home, and all your other assets because the 4-plex is owned by the LLC. They are only able to access the assets in the LLC.

However, if you personally owned the 4-plex and did not set up an LLC to keep your assets separate, you could be vulnerable to unlimited personal liability, and you could be personally responsible for paying back whatever the court awards to the tenant for compensation. For some, that could mean bankruptcy. This is why it’s valuable to set up LLCs for protection.

2. Properly Maintain Your LLC

In order for your LLC to protect you from claims, you must maintain it much like taking care of a garden. Taking care of your garden by watering and feeding it properly is the best way for it to survive and keep it producing food for you. In order for your LLC to survive and keep protecting you, you must pay the annual fee to the state, ensure that minutes are being kept at meetings, and there needs to be a resident agent to accept service of process, or notice of a lawsuit. If you do not follow these easy steps, your business entity will lose its good standing, it will not be able to protect you as you could be vulnerable to piercing the corporate veil, and all your business and personal assets could be taken if a legal decision is decided against you. However, if you follow these steps you will be properly protected.

3. Segregate Your Assets

When creating your LLC, it is important to keep in mind that people are still capable of obtaining all your assets within that LLC. So why put all eggs in one basket? Instead separate your assets into different LLCs to act as a safety net, and ensure they aren’t able to obtain all of your real estate investments or company assets.

4. Get a Wyoming LLC to Hold Your Other LLCs

Certain states have different regulations on LLCs that can offer more protection, so why not take advantage of that? Wyoming is special in that it has great asset protection, great charging order protection, and it doesn’t list your name on the internet. Wyoming LLCs can own other LLCs established in other states. Not only does it have these great benefits, but it also has one of the most affordable state fees. Corporate Direct has also identified a way to ensure that the more preferable protections of Wyoming’s state laws take precedence over other state laws. This is a service we offer through our copyrighted legal language that is not available from any other company or law firm. We call it Armor8® . Learn more about our ultimate Wyoming LLC protection.

5. Use Equity Stripping

Another method of protecting assets is ‘equity stripping,’ sometimes called equity transfer.  With equity stripping you protect your equity by encumbering the property itself. Debt is a form of asset protection. The more debt, the less equity, the lesser chance of litigation. Since debt is asset protection, why not create the debt yourself? This can be done several ways such as spousal transfers, using your property as collateral, obtaining a secured line of credit, and a technique called cross-collateralization. Cross-collateralization is a term used when the collateral for one loan is also used as collateral for another loan. If a person has borrowed from the same bank a home loan secured by the house, a car loan secured by the car, and so on, these assets can be used as cross-collaterals for all the loans.

Do You Own California Real Estate? Courts Create New Tax for LLCs Holding Real Estate

Owners of LLCs Holding California Real Estate, Beware!

The State of California is at it again. A recent case decided by the California Supreme Court allows cities to asses Documentary Transfer Taxes like never before.

When property is transferred by a deed, counties and some cities can charge a transfer tax.

They have done so for over 150 years. In Los Angeles, for example, the transfer of a $1 million property results in a transfer tax of $5600. In San Francisco, a $5 million property transfer results in a $112,500 transfer tax. Although in many cases the tax is split between the buyers and sellers, the income for cities and counties is significant.

However, private transfers, where the deed was left intact and at no time transferred, were never taxed. An example of such a transaction would be where an LLC was on title to the property. The owners could sell their membership interests in the LLC and not pay a transfer tax. This was because the LLC was still on title, and thus no deeding occurred.

The case of 926 North Ardmore changed all this, resulting in higher taxes and many unanswered questions.

If you own California real estate you need to read the case summary below.

CASE SUMMARY

In 926 North Ardmore Avenue, LLC v. County of Los Angeles, 3 Cal.5th 319, 396 P.3d 1036, 219 Cal.Rptr.3d 795 (decided June 29, 2017), a single member limited liability company apartment building owner brought an action for a tax refund after it was required to pay a documentary transfer tax based on the value of the apartment building, when its single member partnership sold approximately 90% of its partnership interests to two trusts. The Superior Court, Los Angeles County, entered judgment for the County; the LLC appealed; and the California Court of Appeal affirmed. The California Supreme Court granted review, and in a 6-1 decision, held that: (1) a transfer tax is not a fee paid in connection with the recordation of deeds or other documents evidencing transfers of ownership of real property, but rather is an excise tax on the privilege of conveying real property by means of a written instrument; (2) that a written instrument conveying an interest in a legal entity that owns real property may be taxable under the Documentary Transfer Tax Act (“DTTA”), even if the instrument does not directly reference the real property and is not recorded; and (3) that the transfer is subject to the DTTA.

The Facts of 926 North Ardmore

Beryl and Gloria Averbook (the “Averbooks”) owned an apartment building at 926 North Ardmore Avenue in Los Angeles (the “Building”). They established a family trust and transferred the Building into it. Beryl died, and after his death, the family trust’s assets, including the Building, were transferred to an administrative trust maintained for Gloria’s benefit. Gloria’s two sons, Bruce and Allen Averbook, were named successor trustees, and they formed the following two entities: 926 North Ardmore Avenue, LLC (the “LLC”), a single-member limited liability company established to acquire and hold the Building; and BA Realty, LLLP, a partnership. The administrative trust was the sole member of the LLC. It also held a 99 percent partnership interest in BA Realty.

Initially, the administrative trust conveyed the Building by grant deed to the LLC. It then transferred its membership interest in the LLC to BA Realty, and divided its 99 percent interest in BA Realty and distributed it to four subtrusts also maintained for Gloria’s benefit. The survivor’s trust received 64.66 percent; the nonexempt marital trust 23.86 percent; the exempt marital trust 0.67 percent; and the bypass trust 9.81 percent. The net result of these transactions did not alter one central reality. When the Averbooks transferred the Building from themselves personally into the family trust, they retained a beneficial interest. The trust became the legal owner, but it was obligated to hold and manage the Building for their benefit. After Beryl’s death, Gloria held the sole beneficial interest. The subsequent transactions moved the Building’s legal ownership among the various entities. But Gloria’s beneficial interest remained unchanged.

Later, a different kind of transaction triggered imposition of the DTTA. The survivor’s trust, the nonexempt marital trust, and the marital trust transferred all of their interests in BA Realty to two trusts maintained for Bruce and Allen, who were each the sole beneficiary of their named trust. As a result, Bruce and Allen each acquired a beneficial interest in the Building they had not held before.

The later transfers were effectuated by written instruments, including six limited partner transfer and substitution agreements. The transaction did not involve the execution of a deed or other instrument transferring title to the Building. The agreements did not mention the Building or its location, nor were they recorded. After the transfers, Bruce’s and Allen’s trusts each held a 44.695 percent partnership interest in BA Realty, which was the sole member of the LLC, which, in turn, held legal title to the Building. In consideration for the transferred interests, Bruce’s and Allen’s trusts each executed promissory notes to Gloria’s three subtrusts. The amount paid by Bruce and Allen was based on an appraisal of the assets of BA Realty, including the Building.

The Majority Opinion in 926 North Ardmore

In a 6-1 decision, the Supreme Court of California noted that the DTTA permits the county to levy a tax “on each deed, instrument, or writing by which any lands, tenements, or other realty sold within the county shall be granted, assigned, transferred, or otherwise conveyed to, or vested in, the purchaser or purchasers,” if “the consideration or value of the interest or property conveyed (exclusive of the value of any lien or encumbrance remaining thereon at the time of sale)” exceeds $100. The Court pointed out that documentary transfer tax is not a fee paid in connection with the recordation of deeds or other documents evidencing transfers of ownership of real property, but rather is an excise tax on the privilege of conveying real property by means of a written instrument.

As such, a written instrument conveying an interest in a legal entity that owns real property may be taxable under the DTTA, even if the instrument does not directly reference the real property and is not recorded. The Court observed that the critical factor in determining whether the documentary transfer tax may be imposed is whether there was a sale that resulted in a transfer of beneficial ownership of real property. Thus, the imposition of a documentary transfer tax is permitted whenever a transfer of an interest in a legal entity results in a change in ownership of real property through a change in a legal entity results in a change of ownership of real property, so long as there is a written instrument reflecting a sale of the property for consideration. The Court concluded that the Building owned by the LLC changed ownership when the partnership interests were transferred, and thus was subject to documentary transfer tax. The Court stated that the following approach would elevate form over substance and would conflict with the purposes of the DTTA:

“[I]f A executed a deed transferring real property to B, that deed would be taxable. But if A created a limited liability company, executed a deed transferring real property to that company, and then executed a written instrument transferring the company to B, the tax would not apply.”

Justice Kruger’s Lone Dissenting Opinion in 926 North Ardmore

Associate Justice Kruger disagreed with the majority opinion, and she wrote a strong dissenting opinion. In her dissenting opinion, Justice Kruger noted the absence of any precedent to justify application of the California DTTA to “run-of the mill transfers of interests in legal entities that happen to own real estate.”

In her view, the majority opinion finds no support either in the language of the DTTA or in “the over-150-year history of the documentary transfer tax.” Justice Kruger concluded that the existing California DTTA requires a direct transfer of real estate to trigger the transfer tax, and that it was the job of the California legislature, and not the job of the California courts, to decide whether the California DTTA should be expanded to transfers of entity interests:

“The majority’s expansion of the DTTA may or may not be a good idea, but it ventures well beyond the statute’s language and historical practice. I would leave it to the Legislature to determine the circumstances under which an entity interest transfer should result in a deemed sale of the entity’s real estate, and how to calculate the tax due in those circumstances.”

BRIEF DISCUSSION

A number of California cities and counties, including, but not limited to, the City and County of San Francisco, Santa Clara County, and the City of Oakland, already have changed their ordinances to apply the DTTA to legal entity changes. In addition, Los Angeles County, the defendant in 926 North Ardmore, and other California cities and counties, have disclosed informally on their websites that the DTTA is due on legal entity changes. Most assuredly, other California cities and counties will apply the DTTA to legal entity changes.

The California Supreme Court’s decision in 926 North Ardmore raises a plethora of unanswered questions, such as: (1) Will the documentary transfer tax be imposed upon the buyers and sellers of the transferred entity interests, or upon the entity itself? (2) How will “value” be determined? (3) Will mergers, acquisitions, and restructuring transactions trigger a documentary transfer tax obligation for real property owned by the entities? (4) Will the documentary transfer tax be imposed upon the full value of the entity interests, or only upon the realty attributable to the transferred entity interests? (5) Will the holding in 926 North Ardmore be applied retroactively or prospectively only? (6) If so, then how far back can the cities and counties go? (7) Will penalties and interest apply? (8) Will taxpayers have to examine various internet websites to determine whether cities and counties will apply the DTTA to legal entity changes? and (9) Will cumulative transfers over time of more than 50% ownership of the entity interests trigger application of the DTTA?

Although no commentator has discussed or even mentioned the issue, it seems apparent that, if the California Supreme Court’s decision in 926 North Ardmore is applied retroactively, rather than prospectively only, then the big loser will be the Mortgage Electronic Registration System (MERS), which has been circumventing California cities and counties out of their documentary transfer tax fees for over two decades.

CONCLUSION

Once again, we see another tax grab by the State of California. Justice Kruger’s lone dissenting opinion basically “got it right.” There is no California precedent, either in the language of the DTTA or in “the over-150-year history of the documentary transfer tax,” to support the majority opinion in 926 North Ardmore. The existing California DTTA requires a direct transfer of real estate to trigger the transfer tax, and it is the job of the California legislature, and not the job of the California courts, to decide whether the California DTTA should be expanded to transfers of entity interests.

In any event, the California Supreme Court’s decision in 926 North Ardmore raises a plethora of unanswered questions that will not be decided for many years to come.

How Real Estate Professionals Can Use Rental Losses as a Tax Write-off

Are you a real estate professional? Do you work over 750 hours a year on real estate activities and are these annual hours over half the time you work in total?

If so, you can offset real estate losses against your ordinary, taxable income. If one spouse is a doctor and the other is a real estate professional, any passive real estate losses can be used to offset the doctor’s ordinary income.

It is a great tax saving strategy.

Which is why the IRS is careful in its scrutiny of such offsets. A recent case further defines the requirements for doing it right. While the discussion below is somewhat technical, you may want to understand the important points.

This applies to you if:

  • You own and manage rental property, or
  • You are a professional in real estate and,
  • Half your hours (a minimum of 750) are dedicated to real estate activities,
  • You have rental property losses that you would like to deduct, and,
  • You have documented logs of rental activities and other substantiating evidence.

If all of the above are true,  then you can deduct the losses against your ordinary, taxable income.

For details of the case and the court findings (which may be somewhat technical) read on.

Discussion

The United States Court of Appeals, Gragg v. United States, 2016 WL 4136982 (9th Cir., Aug. 4, 2016) for the Ninth Circuit was required to determine the scope of 26 U.S.C. §469 with respect to “real estate professionals.” Specifically, the Ninth Circuit was required to determine whether 26 U.S.C. §469 entitles real estate professionals to deduct rental losses without showing material participation in the rental property. The court held that real estate professionals are allowed to deduct rental losses from their taxable income only if they materially participate in rental activities. (2016 WL 4136982, at *1.)

In Gragg, married taxpayers, Delores and Charles Gragg (the “Graggs”), sought to deduct from their taxable income rental losses they incurred from rental properties they owned. Delores was a licensed real estate agent who worked for a real estate brokerage. The issue on appeal was whether 26 U.S.C. §469(c)(7) automatically rendered a real estate professional’s rental losses nonpassive and deductible, or whether it merely removed 26 U.S.C. §469(c)(2)’s per se bar on treating rental losses as passive. The Ninth Circuit concluded that 26 U.S.C. §469(c)(7) did not automatically render a real estate professional’s rental losses nonpassive and deductible, and that 26 U.S.C. §469(c)(7) merely removed 26 U.S.C. §469(c)(2)’s per se bar on treating rental losses as passive. 2016 WL 4136982, at *2.

The Ninth Circuit found support for its decision in Treasury Regulation 1.469-9(e)(1)[1] and the prior Tax Court decision in Perez v. C.I.R., 100 T.C.M. (CCH) 351, at *1 (2010).[2]   2016 WL 4136982, at *3.

The operative provisions of Section 469 may be paraphrased, as follows:

  1. Section 469(c)(1) provides that all activities in which a taxpayer does not materially participate are passive.
  2. Section 469(c)(2) provides that all rental activities are passive, irrespective of how much a taxpayer participates.
  3. Section 469(c)(7) provides that, if a taxpayer qualifies as a real estate professional, then Section 469(c)(2) does not apply.

Significantly, Section 469(c)(7) does not provide that, if a taxpayer qualifies as a real estate profession, then Section 469(c)(1) does not apply. Thus, even if a taxpayer qualifies as a real estate professional, the taxpayer still must show material participation in rental activities in order to avoid classification of rental activities as passive. Stated in other words, even if a taxpayer qualifies as a real estate professional, rental activities are not thereby automatically deemed to be nonpassive. This is the proposition that the Graggs argued and lost before the Ninth Circuit. The Graggs plainly were wrong.

CONCLUSION

Real estate professionals are allowed to deduct rental losses from their taxable income only if they materially participate in rental activities. To prove participation it is strongly suggested you keep a log and other supporting evidence of your real estate activities.

[1]Treasury Regulation 1.469-9(e)(1) provides that a taxpayer who qualifies as a real estate professional can treat rental losses as nonpassive, but only so long as she materially participates:

“Section 469(c)(2) [the per se rental bar] does not apply to any rental real estate activity of a taxpayer for a taxable year in which the taxpayer is a qualifying taxpayer under paragraph (c) of this section [i.e., a real estate professional].  Instead, a rental real estate activity of a [real estate professional] is a passive activity under section 469 for the taxable year unless the taxpayer materially participates in the activity.” (Emphasis added.)

Likewise, Treasury Regulation 1.469-9(e)(3)(1) confirms that even taxpayers who establish real estate professional status must separately show material participation in rental activities (as opposed to other real estate activities) before claiming any rental losses as nonpassive:

“[I]f a qualifying taxpayer develops real property, constructs buildings, and owns an interest in rental real estate, the taxpayer’s interest in rental real estate may not be grouped with the taxpayer’s development activity or construction activity.  Thus, only the participation of the taxpayer with respect to the rental real estate may be used to determine if the taxpayer materially participates in the rental real estate activity under [the material participation safe harbor provisions in] § 1.469–5T.” (Emphasis added.)

[2]In Perez, supra, 100 T.C.M. (CCH) 351, at *2, the taxpayer argued, as did the Graggs, that because she was a qualifying real estate professional pursuant to section 469(c)(7)(B), all of her real estate activities, including rental activities, were not passive, and, therefore, she was not subject to the passive activity loss limitations. The Tax Court disagreed, ruling that “[c]aselaw clearly requires that a taxpayer claiming deductions for rental real estate losses meet the ‘material participation’ requirement[].”

Avoid Accidentally Breaking the Law with Checkbook IRAs

IRA (Individual Retirement Account) can provide greater flexibility in investing than a 401(k), but it can also be surprisingly easy to jeopardize your nest egg if you’re not careful to follow the letter of the law.

When you have money in your IRA (Individual Retirement Account) you can make a wider range of investments than you can with a 401(k). You can invest, for example, in real estate, mortgages, tax liens, joint ventures, stocks you select and certain precious metals. The IRS doesn’t allow IRA investments into artwork, rugs, antiques, gems, stamps and the like.

When you want to have more control in directing these investments you can set up a self-directed IRA account whereby a custodian or trustee helps you manage the account and file all the required IRS reports.

The trustee will also help you steer clear of the many prohibited transactions set forth by the IRS. These are self-dealing or conflict of interest transactions, which benefit the IRA holder or other disqualified persons (think family members), and not the IRA account.

If you are caught in a prohibited transaction, your IRA account is treated as being distributed. This means penalties and interest are owed, which can whittle your IRA account down to zero. Not good retirement planning.

Prohibited transactions include:

  • Borrowing money from the IRA
  • Selling property to the IRA
  • Compensation for managing it
  • Using the IRA as security for a personal loan
  • Personally guaranteeing an IRA loan
  • Personal use of IRA owned property
  • Providing services to an IRA investment, including real estate services

The last prohibited transaction has led to a great deal of confusion. If your IRA invests in a single family home you rent out to tenants, can you go in and fix a toilet? More broadly, with an IRA can you be involved in ‘Active Landlording?’ The rules consider that a prohibited transaction—you are providing services directly to your IRA plan.

To stay within the rules you must have your self-directed IRA trustee hire a plumber to fix the toilet. So not only do you have to pay the plumber, but you have to pay the trustee to pay for the plumber.

Into this vortex the promoters of Checkbook IRAs (also called Checkbook LLCs) have arisen.

Their pitch is simple. Instead of paying the trustee for every transaction, you set up an LLC owned by the IRA. Then you are manager of the LLC and get to write checks for it. (Hence, Checkbook IRA.) In doing so, you can save on all the trustee fees.

It sounds great. But there is one big problem.

If you can’t write checks for your self-directed IRA plan (which you absolutely cannot!) then how can you write checks for the LLC owned by the IRA? Aren’t you personally managing your IRA monies? Aren’t you personally providing services to your IRA by managing its money?

Of course you are. And then what if you need to put money into the LLC account?
Once you’ve funded the LLC it becomes a disqualified entity. Any additional outside monies you put into it are a prohibited transaction.

Oops. All the penalties and interest now owed have wiped out your IRA account.

Equity Trust Company is one of the nation’s largest self-directed IRA trustees. They know the law and won’t accept Checkbook IRA arrangements. Jeff Desich is the CEO of Equity Trust. Jeff states, “I strongly believe there is a tremendous risk with using the Checkbook IRA scheme.”

If that admonition is not enough, consider the issues on the administration of the account. With the Checkbook IRA you are now the custodian, you are now responsible for maintaining all the paperwork associated with the file, and responsible for any mistakes that are made. If you get audited will your paperwork stand up?

The safer course is to stay away from Checkbook IRAs. For more information see my book Finance Your Own Business: Get on the Financial Fast Track.

Learn How to Fund Your Start-Up

For more information on the good and bad ways to fund your business and investments please see my book, co-authored with credit expert Gerri Detweiler, entitled Finance Your Own Business.

Cyber Crime: The Hacking of Real Estate Transactions

Is anyone protected from a cyber security breach? And what steps can you take to protect yourself?

Universities, retailers and even the government have all been exposed to cyber thieves. The government’s office of Personal Management lost over 5 million fingerprint records, unique data points that can’t be altered like a PIN code. The IRS lost confidential financial information on hundreds of thousands of tax payers. No one knows the cost to correct the error. One can only hope our nuclear codes are not stored somewhere on the internet.

Real estate transactions are the next activity under cyber attack.

Why? Because a lot of money can be reached. Hackers will start by breaching an email account of a busy broker. This is easy to do. Many brokers and agents do business from public places such as coffee shops. Their email address is found on marketing material and for sale flyers. The hacker can easily gain access to an email account and then follow what the broker, the escrow officer, the banker and all the others in a transaction are doing.

Suppose John and Mary are two brokers on each end of a large transaction. After learning details of the deal by following John and Mary’s email exchanges the hacker then inserts himself into the exchange through ‘spoofing’.

To spoof is to fool by a hoax or to play a deceitful trick on someone. The spoofing here is to pretend to be another person.

The hacker knows that Mary’s email address is [email protected] He creates a new account as [email protected] and inserts himself into the discussion. The hacker knows the details of the transaction and poses a knowledgeable question. John responds to this simple request from Mary at the new email address. Soon, the emails – all of which look legitimate and contain factually correct information – are being directed at crucial time to the spoofing hacker. A request for a change in wiring instructions does not arise any suspicions. Until it is too late and the money is gone.

What Steps Can You Take to Prevent Fraud?

Cyber law experts suggest a number of steps to take to prevent fraud. Some of these include:

  • Use the best firewall and anti-virus programs you can afford.
  • Frequently change the user names and passwords on your email accounts.
  • Use really long passwords of at least 20 characters or more. The longer the password the harder it is to crack.
  • Transmit sensitive information by means other than email.
  • Before wiring any funds contact the person providing the wire instructions by telephone to verify.
  • Clean out your email accounts regularly.
  • Trust your gut if an email looks suspicious or if you aren’t sure about a link, don’t open it.

What if there is a loss associated with a security breach? Do you have the right insurance?

Most general liability and business insurance policies do not cover cyber claims. However, cyber liability insurance is available. You should consider asking your insurance agent about it.

I have written more about cyber liability insurance in my books, Finance Your Own Business and Scam-Proof Your Assets. No matter what business you are in it is worth considering such a policy.

The cyber criminals are only getting more aggressive. You need to be prepared for an attack.

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How to Create a Real Estate Investment Business Plan in 4 Steps

We’ve all heard the expression, “Those who fail to plan, plan to fail.” In real estate, this saying certainly holds true. It’s essential that you develop a workable plan and start building a team of experts before you get started, so that you start off on the path to success. For those of you just getting started, you’re wondering where to begin. And the answer is, with taking a good, hard look at your financial affairs in order to develop an accurate, comprehensive financial report card.

Step #1: Preparing Your Financial Report Card

You can’t move forward until you determine where you are right now. Unfortunately, this basic premise is overlooked by many investors, and it’s a crucial foundation for success.

Start creating your financial statement by developing an income statement that lists your monthly income and expenses. Most of us are checkbook-driven; we put our paychecks into our checking accounts, pay bills with that income throughout the month, and, if we’re lucky, we have enough income each month to pay those bills. The income statement will show you your monthly financial activity.

Next, you’ll create a balance sheet, which lists your assets and liabilities.

loopholes of real estate 26Your assets, as you’ll recall, are the things that generate wealth for you, such as investments, savings accounts, stocks, 401(k) plans, mutual funds, real estate, or a business that you own. Your liabilities are all the things that take money away from you, which might include your credit cards, the remaining balance on your car loan, or the mortgage on your home. Your balance sheet will give you a picture of your current wealth. For more tools on creating your financial statement get a copy of my book, Loopholes of Real Estate.

Your personal financial statement will bring your financial goals into sharp relief. You’ll see where your debt is concentrated or how to pay it down, and you might see where you could bolster your asset column. (Here’s a list of 29 small business financial resources.)It may lead you to form a plan to decrease expenses or increase income. Some decide to downsize their homes in order to free up some money for investment, while others may opt to rent out their existing home and move to a smaller home to generate cash flow, increase passive income and decrease expenses. Only you can decide how to address your financial situation. Seeing your assets and liabilities in black and white will open up a lot of possibilities you hadn’t considered before.

But unless you plan to increase your working hours, ask for a raise, or seek a better-paying job, your income options will be limited. The only real way to significantly improve your income will be to increase your passive or portfolio income.

Step #2: Setting Your Real Estate Goals

Passive income is the suggested method for growing wealth. It is not only the fastest method, but is also the easiest, because it means other people’s money, time, and energy are working for you.

If you’re like most people, your financial report card reveals that zero percent of your income is passive. So your first step is to determine what percentage of your income you’d like to make passive. Start with where you’d like to be one year from now, as well as a longer-term goal of five years from now. What would a reasonable monthly passive income goal be? $1,000? $5,000? $10,000? More than that?

Remember that your goals are dependent on what you’re willing to do to make them happen. Know that you can also re-calibrate your goals down the road as you learn more and determine what works and what doesn’t.

A lot of people, once they’ve made up their minds to invest in real estate, decide to jump right in and figure things out as they go along. Some people learn best by doing and making the occasional mistake, while others do what they can to head off those mistakes by completely educating themselves first and consulting with advisors and investors. Everyone is different, and you should do whatever is most comfortable for you.

Essentially you’ll want to determine something specific—how much you want to save, how much of an initial investment you plan to make, what you’ll do with that initial investment, and over what period of time.

For example, maybe you’ve decided that within six months, you want to save $10,000, which you’ll then turn around and invest into a piece of rental property by the end of one year. If this is doable for you, it’s a worthy goal. From there, perhaps, you might decide that within ten years you want to have five rental properties.

Beyond that, you have other decisions to make: What kind of properties you’ll invest in, where, and what to do with them.

The following are your numerous real estate options:

  • Single-family homes
  • Condominiums
  • Duplexes
  • 4 plexes
  • Trailer parks
  • Apartments
  • Commercial office space
  • Commercial industrial space
  • Storefront retail
  • Hotels
  • Motels

Each of these has its own choices as well—apartment complexes vary in size, so are you interested in 20-unit complexes, 100, or more? Starter-market or high-end gated communities? High-rise office, strip-mall retail… your choices are plentiful.
Then you must decide where you want your properties to be. Are you looking for properties nearby in your town, in a neighboring town, in another state, near water, urban, rural?

Now, what will you do with the property? You could:

  • Buy foreclosures cheaply, without intending to earn immediate cash flow from them,
  • Fix and flip, intending to purchase cheaply, refurbish, and resell for a profit,
  • Buy and hold, capitalizing on appreciation, or
  • Buy, hold, and rent, earning both appreciation and cash flow.

The Rich Dad strategy is buying and renting, which maximizes short- and long-term income potential.

3. The Wisdom of Investment Specialization

Because the real estate world offers so many options, it’s a good idea to focus on a particular area of specialization. For instance, you might become an expert in buying, holding, and renting small, one and two-bedroom apartment buildings in a particular area of town. Perhaps you used to live in an apartment in that area years ago and understand the needs of that community and that type of resident. Each geographic area has its own unique dynamic, its own zoning regulations and its own distinctive resident, so it’s a good idea to focus on one particular area. As you become an expert in one investment area, you will be more apt to learn another area quickly.

Another word of advice: Start small. You will make mistakes, so make them early on, with low-risk, low-end properties in which there isn’t as much at stake for you.

4. Stick With Your Game Plan

One final point about why it’s a good idea to stick to the same game plan when you’re investing in real estate: When you assemble your team of advisors, one of them will be your real estate agent. He or she will be an expert in one particular sector—the one you’re investing in—but most likely won’t be an expert in other sectors. For example, he or she might specialize in duplexes, but not strip malls.

So by sticking with one sector, you can retain the same team of advisors without having to seek others. And as far as your team is concerned, it’s best to find them, understand their strengths and use them as your investment vehicle. This leverages experience. When you’re ready to broaden your investment horizons, you can seek new team members.

Before You Invest In Real Estate, Educate Yourself

I’m not suggesting that you need to know everything. You don’t. You’ll continue to learn as you go. But you must educate yourself in the basics to get started on the right foot. A little education goes a long way in accomplishing four essential goals:

1. Demystify Investing and Lessen Your Fear

Learning about real estate will demystify it for you, reducing your fear of the unknown. Without that fear, you’re more likely to take the leaps necessary to progress to the next level and reach your goals. As I mention below, take in as much information as you can through books, seminars and mentors.

2. Know that Ordinary People Can Be Successful

It will show you that you don’t need to have any innate real estate talent or know-how. You’ll truly see that anyone can do this. You don’t need a degree in law, finance or real estate, and you don’t need outrageous sums of cash. Ordinary people just like you, with ordinary reserves of cash, have achieved great results in real estate investment, and you can too!

3. Pick an Area of Real Estate to Specialize In

It will help you to narrow down which area of real estate you’d like to specialize in. When you understand some of the unique qualities of each type of real estate, you’re more likely to discover the type and location that best suit your investment style and needs. If you need help developing a Real Estate Investment Business Plan, check out my guide.

Learn How to Create a Real Estate Investment Business Plan in 4 Steps. How to Create a Real Estate Investment Business Plan

4. Identify Experts to Assist with Your Investment Strategy

It will also help you to identify which experts might be best for your particular kind of investment strategy. When you assemble your team of advisors, one of them will be your real estate agent. He or she will be an expert in one particular sector—the one you’re investing in—but most likely won’t be an expert in other sectors. For example, he or she might specialize in duplexes, but not strip malls. So by sticking with one sector, you can retain the same team of advisors without having to seek others.

 So where do you get all this education?

A good place to start is to read books, newspapers, magazines and online articles on related topics. One resource will lead to another, and then another, and as you find yourself asking questions or wanting more information on a specific issue, it will guide you to the next article or book.

For more on this topic, check out my book, Loopholes of Real Estate.

Loopholes of Real Estate by Garrett Sutton

LoopholesRE Sutton.Front Cover.Final .HiRes .2019 scaledLoopholes of Real Estate reveals the legal and tax strategies used by the rich for generations to acquire and benefit from real estate investments. The book clearly identifies how these loopholes can be used together to maximize your income and protect your investments.

Written in easy to understand language, this book de-mystifies the legal and tax aspects of investing with easy-to-follow, real-life examples.