Vesting.
Vesting
The vesting of a property is the form of ownership of that property. It is what person(s) or other legal entity hold title, that is, will be shown as grantee on a deed. The decision regarding vesting is always an issue when buying or financing real
estate and is often an issue that is revisited for reasons of estate planning.
Vesting is an important decision that should be made after careful study and often requires consultation with an attorney and/or a CPA.
In practice, it may be important to make this decision prior to writing a purchase offer or applying for financing, as the vesting can sometimes affect the seller’s or lender’s decision. If you expect the seller to carry any financing, he will want to know the vesting in order to judge his risks as a lender. Even if no seller financing is involved, the seller is tying up his property for a period of time (sometimes several months) and the vesting can affect his decision. While you may get away with using “John Doe and/or nominee” in your offer, a knowledgeable seller (or his agent) should not allow you to do so.
Conventional lenders may also have restrictions related to vesting. As examples, they (1) often require that title be taken as individuals rather than as a Revocable Living Trust, but allow transfer to the Trust after closing the loan escrow and (2)
will almost certainly require that principals guarantee loans of limited liability entities that are not of substantial financial standing.
It is very important that the correct vesting name(s) be provided to escrow. Even a relatively minor error, for example, a missing initial or Jr. can either cause a delay in closing escrow because all documentation must be replaced or can cause a problem when refinancing or selling the property years later.
There are many choices for vesting, including the following or similar in most states:
- Sole Ownership
- Joint tenancy with right of survivorship
- Community property
- Community property with right of survivorship
- Tenancy by the entireties
- Tenancy in common
- Multiple persons, as joint tenants, with right of survivorship.
- Married couples, as joint tenants, with right of survivorship or, in community property states, as community property, or as community property with right of survivorship.
- Legal entity ownership
Vesting as community property is available in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. In Alaska, couples can opt in for community property. The rest of the states and the District of Columbia are governed by common law.
Sole Ownership
Sole ownership means that one person has complete ownership of, and control over, the property, including how to dispose of it. As the sole owner, you may sell it, divide it, gift it, or bequeath it to your heirs in accordance with your desires. Upon your death the property would pass in accordance with your wishes pursuant to your will or, if there is no will, in accordance with state law. Sole ownership can be either as an person who has not been married, a person who has been married but is divorced, or as a married person as sole and separate property (spouse must consent).
Examples are:
- John Doe, a single man
- John Doe, an unmarried man
- John Doe, a married man, as his sole and separate property
Joint Tenancy
Joint tenancy with right of survivorship is the concurrent ownership by two or more persons of a parcel of property which the ownership and control would be shared equally among all the joint owners during their lifetimes. The entire property may only be sold or transferred with the written consent of all joint owners. Upon the death of one of the joint owners the interest passes to the remaining joint owners rather than to heirs of the deceased.
Example: John Doe and Mary Doe, husband and wife, as joint tenants
Community Property
Property acquired by husband and wife, or either during marriage, other than by gift, bequest, devise, descent, or as the separate property of either is presumed community property. Property acquired by him/her prior to the marriage or during the marriage by gift or devise is his/her separate property and the one who owns it can deal with it alone without the consent of the spouse.
Example: John Doe and Mary Doe, husband and wife, as community property.
Community Property with Right of Survivorship
Acquisition is the same as joint tenants, but the acquisition document must specifically state “with right of survivorship.” Terminating the interest of the deceased spouse is the same as joint tenancy. The main difference between “joint tenancy” and “community property with right of survivorship” is potential tax advantages/disadvantages upon death.
Example: John Doe and Mary Doe, husband and wife, as community property with right of survivorship
Tenancy by the Entireties
Tenancy by the entireties is basically a joint tenancy with right of survivorship between a husband and wife. Only a husband and wife may hold property as tenants by the entireties. As in joint tenancy, both spouses must consent in writing for the transfer or sale of the property and the surviving spouse would receive the entire property upon the death of his or her spouse.
Tenancy in Common
Tenancy in common is a type of concurrent ownership in which each tenant owns and controls an undivided interest (not necessarily equal or arising concurrently) in the property. Co-owners can be individuals and/or any type of legal entity. The entire property however, can only be transferred or sold with the written consent of all owners. However, a co-owner can sell or otherwise transfer or dispose of their interest in the property at any time, including bequeathing it
to heirs by will or otherwise. There is no right of survivorship; each tenant’s interest, upon death, vests in his or her heirs.
Example: John Doe, a single man, as to an undivided one-fourth interest, and George Smith, a single man as to an undivided three-fourths interest, as tenants in common.
Multi-Owner Differences
Each manner of vesting for multiple individuals has advantages and disadvantages. Differences include (1) whether or not probate is required upon death of a co-owner and (2) in the case of married couples, whether or not a co-owner receives a stepped up basis upon death of the other co-owner.
Legal Entity
There are a variety of legal entities available for real estate ownership. With a few exceptions, any entity that can operate a business can be the titled owner of real estate.
Partnership – In a general partnership, all partners are jointly and severally liable for the acts of other partners that are performed on behalf of the partnership. In a limited partnership, the general partners have the same liabilities as above,
while limited partners are usually liable only to the amount of their investment. In both cases tax benefits flow through to the partners, with the allocations not necessary based upon share of capital contribution.
Corporation – A “person” created by state law, a corporation has shareholders (owners), a board of directors, and officers. Shareholders are liable only to the amount of their investment. Directors and officers are also protected from
corporate liabilities, but can incur liability if they commit acts that allow piercing of the “Corporate Veil. For a regular “C” corporation tax benefits are not passed through to shareholders, the corporation is taxed on profits, and shareholders are taxed on dividends (double taxation). By electing to be an “S” corporation, certain tax benefits can be passed through to shareholders and double-taxation can be avoided.
LLC, Limited Liability Company – A LLC is a separate legal entity formed by filing articles of organization with the secretary of state. LLCs and similar entities combine certain features of partnerships with certain features of corporations, most notably, limited liability for its owners and managers. LLCs are more like a partnership, providing management flexibility and the benefit of pass-through taxation. In certain circumstances, a limited liability limited partnership or a limited liability partnership might be appropriate.
Trust – Title to real property may be held in Trust. The Trustee of The trust holds title pursuant to the terms of the Trust for the benefit of the Trustor/Beneficiary. Trusts are usually utilized for reasons related to estate planning.
Limited Liability Entities
Life is full of risks to one’s health, safety, security, and finances. When it comes to financial risk, operating any business is risky. However, being a landlord can be more risky than average. Landlords are sued more often than any other group of business owners in America.
How well you survive a major lawsuit related to one of your properties can depend entirely on how ownerships of your properties are vested.
Landlords must understand that having liability insurance policies, no matter how high the coverage limits, doesn’t necessarily provide adequate protection in the event of a judgment in an amount significantly above the policy’s limit or for
an incident not covered by the policy. All assets held in the name of an individual are at risk in the event of a judgment resulting from an event related to any one property owned by the individual. Assets at risk include other rental properties, personal residences, stocks & bonds, bank accounts, and all other personal property of value (jewelry, furnishings, antiques, art, autos, boats, etc.). Not only are all assets at risk, but so is future income.
The outcome for such an event will be substantially different if the rental properties are vested in limited liability entities.
Furthermore, it is absolutely best to have a separate LLC for each property. The reason for this is that a large judgment against an LLC resulting from a claim against one property of multiple properties owned by the LLC would result in all other properties owned by that LLC being available for satisfaction of the judgment.
Estate Planning
Many think that estate planning consists of putting property into a joint tenancy, community property (with or without right of survivorship), or tenants in common form of vesting. There are several problems and risks in inherent in owning or attempting to transfer your property to your heirs or others by one of these types of concurrent ownership. Some of the potential problems include those discussed in the following paragraphs.
Transferring property can in itself cause problems related to gift tax or income tax. Transfer of title is also a violation of the alienation clause found in most real estate loan documents and can result in acceleration of the loan – that is, making the balance of the loan immediately due and payable.
Having property vested in a Revocable Living Trust is an estate planning tool that is often used these days. However, a Revocable Living Trust provides no liability protection during the life of the Trustor.
The bottom line is that estate planning is complicated and should usually be done in consultation with competent attorneys who specialize in the issues.