By Timothy Barrett, Trust Counsel | Kiplinger
It is not uncommon for a trust beneficiary to request a distribution or distributions from the trust principal to help buy a new home and assist with the costs of homeownership. These are reasonable requests if the trust can absorb these costs and still meet its other trust purposes. Other times, the trustee will be required or encouraged to purchase a new house as a trust asset when requested. Most times, trust ownership of a personal residence creates more problems than it resolves.
Requirements are uncommon
Some trusts arising from a decedent estate will hold the home belonging to the trust’s creator (also known as the settlor) without any instructions for its disposal or retention. Outside of very large trusts ($50 million and more), a requirement to actually purchase homes for beneficiaries in the trust is far less common. More common in a large trust (about $5 million and up) are terms that allow the trustee to purchase a home for a beneficiary outside the trust or retain the settlor’s home in the trust for a beneficiary’s use, including purchasing a replacement home when requested. But I find that most older trust agreements are silent regarding what to do about a retained home or a request to purchase a new one.
In every case, the trustee must propose a plan that will, hopefully, satisfy the beneficiary without undue risk to the trust estate or exceeding the trustee’s powers. The most relevant considerations for homeownership in a trust are the competing needs of other trust beneficiaries, the purchase price and costs of maintaining the home, the size of the trust relative to those costs, other sources of income and resources available to the beneficiary, and the interests of the remaindermen (beneficiaries who will take from the trust when the current beneficiaries’ interests terminate). The terms of the trust may require the trustee to ignore some of these considerations.
Complex situations
Each situation requires one or more decisions that could expose the trustee to a charge that it has acted imprudently. Consider this example:
The sole beneficiary of a trust created by her mother is 25 years old, unmarried and was sharing the home when her mother passed away. The trust is the beneficiary of a $200,000 IRA, owns $200,000 in cash and investments, and includes the residence, which is appraised at $200,000. The beneficiary works at a retail store earning about $24,000 a year.
The trust allows, but does not require, the trustee to retain the home for the beneficiary’s use and allows the trustee to pay for the costs of homeownership. The trust also requires that the trustee distribute all the trust income to the beneficiary annually and distribute one-third of the trust principal to the beneficiary at age 25, another half of the trust principal at age 30, and the remainder of the trust principal at age 35, effectively terminating the trust. Therefore, the trustee must immediately distribute $200,000 in trust principal to the beneficiary and still owes the beneficiary all the trust income earned in that year.
The trustee must first consider that the annual costs for trust fees, property taxes, homeowners insurance, utilities and maintenance will average $15,000 a year. The trustee most likely will choose to make the required $200,000 distribution using a combination of an IRA withdrawal and non-retirement funds.
Weighing the options
But should the trustee require that the beneficiary pay part or all the costs of homeownership? The trustee may want to retain trust liquidity in case the trust income is insufficient to cover costs that exceed the beneficiary’s resources. Probably, yes.
What if the beneficiary asks the trustee to sell the house and, instead, pay her rent and utilities for an apartment so she has additional funds available to purchase a car, pay the auto insurance, buy clothing, groceries, etc.? Would that be a prudent solution? Probably, yes.
What if the beneficiary asks the trustee to terminate the trust and distribute the trust assets to her because continuing the trust would be uneconomical? Would that be prudent? Probably not at age 25, but it may be a better idea when she reaches age 30.
The other end of the spectrum
Another example looks at the other end of the trust spectrum:
The surviving spouse passes away, leaving an estate and several irrevocable trusts established by her deceased husband. She is survived by her three grown children, all married, independent and employed, with children of their own. Once the estate taxes and costs are paid and the required transfers are completed (which may take a year or more), the merged family and insurance trusts for the benefit of these three children are designed to divide into three equal and separate trusts, one that benefits each child, or the children of any deceased child.
The family trust owns a personal residence that has appraised for $600,000. It owns a vacation condo, appraised for $1 million, that was used by the family from Thanksgiving through March each year and as a vacation rental the other months. There are retirement accounts made payable to the separate share trusts valued at $2 million and another $2 million in cash and investments in the trust.
What if the children all agree to retain the condo for their continued use and rental income? What if one of the children wants to sell her home and use the family home as part of her share? Should the trustee agree to these requests? Maybe.
Choices for the trustee
The trustee could delay the trust division and advise that the trust establish a limited liability company that will own the vacation condo equally among the three separate trusts. The trustee will likely require indemnification from liability for retaining the condo in this LLC and that the LLC be managed by a manager selected among the children.
An experienced trustee may also entreat the children to execute a written agreement that addresses the anticipated, and unanticipated, costs of the condo to themselves individually and to each trust’s estate. This agreement would seek to address a method for scheduling personal use of the condo; for setting the rental fees; for establishing who will take responsibility for engaging condo management, housekeeping and maintenance; and, finally, for approving and funding the condo’s upkeep and repair costs. This manner of advisory services is critical to ensuring that a trust’s purposes are met and that its administration contributes to the family’s financial success and lifestyle.
As to the personal residence, the trustee may agree to place it entirely in this beneficiary’s trust. The beneficiary may instead apply the proceeds from the sale of her current home, supplemented by a residential loan, to purchase the residence from the family trust. This will allow her trust to retain liquidity for the condo expenses if she lacks the resources to pay them herself. Her trust can also pay some or all of her monthly mortgage and other homeownership costs.
All things considered
There are countless situations involving trust ownership of a home. The unifying factor is that a personal residence is an illiquid asset that produces no income and may be costly to own and maintain. The expenditure of the home’s value for lifestyle and other needs is only available through liquidation or mortgage. As a trust asset, it is subject to trust fees and other administrative costs that would not apply if owned outside the trust.
Read more: How To Invest In Real Estate: Your Guide To Getting Started
It may be better protected from bankruptcy creditors in a trust, but it also exposes other trust assets to judgment creditors for injuries sustained on the property. It may also escape consideration in a property settlement after a divorce but not usually if marital income and resources are applied toward the home’s maintenance and improvement.
All things considered, homeownership in a trust is not likely the best option.
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