Beware: Transfer of Real Property to Entity May Void Title Insurance Policy

Many people these days are transferring real property to a trust or an LLC for asset protection or estate planning purposes. If you have recently done this or are planning to, there is something that you should know. The type of deed by which the real property is transferred is extremely important.

Real property is transferred by deed. Deeds come in a variety of forms including General Warranty Deeds, Special Warranty Deeds, Bargain and Sale Deeds and Quitclaim Deeds. Each of the General Warranty Deed, Special Warranty Deed and Bargain and Sale Deed contain warranties regarding the title to the property, which are provided by the Grantor to the Grantee. A Quitclaim Deed, on the other hand, makes no warranties. In practical terms, the Quitclaim Deed only conveys the interest held by the Grantor.

While there is not a lot of legal precedent regarding this topic, a Michigan Appellate Court was presented with this issue. In that case, the 100% shareholder of a corporation purchased a building. The title insurance policy issued for the property named the corporation as the insured. For estate planning purposes the property was transferred by Quitclaim Deed from the corporation to the shareholder’s wife. After the transfer to the wife, it was discovered that the property was burdened by an undisclosed easement, and the corporation sued under the title policy.

The Court found that upon execution of the Quitclaim Deed transferring the property from the corporation to the wife that the coverage under the title insurance policy terminated. The Court stated that the policy terminated because the corporation did not retain an interest in the property. A Maryland Court has also held that a similar transfer by a Special Warranty Deed voided the title policy.

In each case, the Michigan and Maryland Courts would have likely ruled differently if the property was transferred by General Warranty Deed. A General Warranty Deed provides specific warranties from the Grantor to the Grantee that the Grantor will forever defend the Grantee from and against any defects existing in the title to the property, excepting the exclusions that are mentioned in the title insurance policy. Therefore, if the properties in the above cases were transferred by a General Warranty Deed, the Grantee would sue the Grantor for the defects in title based on the warranties made in the General Warranty Deed, and the Grantor would sue the title company under the title policy.

For little or no additional time or expense a General Warranty Deed can be utilized in favor of a Quitclaim Deed, which will likely insulate the downstream Grantee in the event of title defects. Contact the attorneys at Nevantage Law Group to discuss the best way to transfer your real property to a trust or LLC.

Nevada’s Cure for Out-of-Sight IncomeTaxes

If you live in a state with high income taxes, such as California, and are looking for a way to significantly reduce that tax, there is an estate planning technique in Nevada that may be the solution you are looking for. Last year the IRS issued Private Letter Ruling 201310002 approving the use of a Nevada Incomplete Non-Grantor Trust (“NING Trust”). This Private Letter Ruling confirms numerous letter rulings dealing with similar trusts formed in Delaware, as well as a California Franchise Tax Board Technical Advice Memo.

A properly structured NING Trust may permit a resident of a state with high income taxes to avoid state income taxes on interest, dividends and capital gains. The reason that the NING Trust is able to offer such benefits is that the trust is a hybrid structure between a grantor trust and a non-grantor trust, which combines beneficial qualities of each to create a powerful tax mitigation vehicle.

The NING trust must be carefully drafted in order to avoid “Grantor” status by giving up a sufficient amount of control over the assets in the trust, but not giving up too much control, which would create a completed gift and trigger Federal gift tax obligations. The Grantor is the person establishing the trust. The income of a Grantor Trust is taxed to the Grantor, while with a Non-Grantor trust, the trust is a separate tax-paying entity and the trust is responsible for paying taxes on its income.

The foregoing Private Letter Ruling provides that a trust must possess all of the following characteristics in order to qualify as a NING Trust (i) the trust is self-settled, and provides the Grantor with an ability to receive discretionary distributions; (ii) the Grantor is not taxed on the trust income in the Grantor’s state of residence because the trust is a non-grantor trust; and (iii) the Grantor has a non-general power of appointment, which means that the Grantor has the ability to decide when and how much trust property will be distributed and (iv) the assets transferred to the trust are transferred in a manner that does not constitute a complete gift.

While many states have passed laws that permit the creation of a self-settled trust that creditors are not able to reach, the laws in Nevada are more beneficial than any other state to those seeking to take advantage of this vehicle. The reason is that Nevada permits the Grantor of the trust to maintain a lifetime power of appointment over the assets in the trust, but does not permit creditors to reach the assets of the trust. In layman’s terms, the person setting up the trust may maintain control over the assets placed in the trust. As such, not only does this trust provide tax savings, but it also provides asset protection. However, one caveat is that pursuant to Nevada law, in order for the trust to qualify as a Nevada trust, the trust must have at least one natural person serving as trustee that resides in Nevada, or have a bank or trust company, located in Nevada, serve as trustee. Additionally, the tax savings only occur while the grantor retains only a discretionally right to receive distributions. If the grantor’s right to received distributions becomes fixed, or to the extent distributions from the trust are received by the grantor, then state tax liability would be incurred.

Example of Tax Savings: Taxpayer, a California resident has $2 million investment portfolio that produces $120,000 of interest, dividends and capital gains each year. Given California’s current state of income tax rate of 12.3% on most high net worth individuals (13.3% on those with California taxable income greater than $1M), the taxpayer could save almost $15,000 each year in California taxes by transferring the portfolio to a NING. Additionally, if the taxpayer can reinvest the annual tax savings at six percent after tax return, the saving would grow to $542,995 after 20 years. If you would like to reap the benefits of using a Nevada Incomplete Non-Grantor Trust, contact the attorneys as Nevantage Law Group, and they will sit down with you and explain how you can benefit from this powerful tool.