Real property is the primary asset in many estate plans, and it warrants special attention. The distribution of cash and family heirlooms is relatively straightforward compared to real estate, which is often accompanied by a mortgage and insurance. As an estate planning attorney, you should use caution when transferring real property to a trust or to entities such as limited liability companies (LLCs) due to the many moving parts. Read on to learn about three mistakes to avoid when transferring real property.
1. Unintentionally Triggering the Due-on-sale Clause
A mortgage agreement typically contains a due-on-sale clause, stating that the mortgage must be repaid in full when an interest in the mortgaged property is sold or transferred. Some title transfers are exempt under the Garn–St. Germain Depository Institutions Act of 1982 (the Act), however. For example, transfers to an inter vivos trust do not activate the due-on-sale clause, but transfers to an LLC or other ownership vehicle might.
If that were not complicated enough, the implementing regulations of Garn–St. Germain (found at 12 C.F.R. part 191) appear to conflict with the language of the Act. The Act protects certain transfers of residential real property containing less than five dwelling units; actually occupying the property is not listed as a requirement as long as the right of occupancy is not affected by the transfer. Conversely, the regulations seem to add an occupancy requirement and do not refer to the size of the property. However, the court in the unpublished decision of Baldin v. Wells Fargo Bank, No. 3:12–cv–648–AC., 2013 WL 794086 (Feb. 12, 2013), ruled that the regulations’ mention of the occupancy requirement was ultra vires and outside the intent of Congress.
Most estate planning clients do not have real estate portfolios with multiple properties and are not likely to be affected by this conflict: many clients have only a single-family home that is their primary residence. Transferring such a property to a trust is likely covered by the Act, so that the due-on-sale clause of the property’s mortgage would not be triggered upon the transfer. However, clients transferring a property to an LLC or whose property contains five or more units should obtain written approval from the lender to avoid triggering the due-on-sale clause.
Of course, lenders may not grant approval, and they may not discover the transfer on their own. So, you can apply your own discretion as an estate planning attorney regarding whether to bring this issue to a lender’s attention.
2. Accidentally Terminating Title Insurance Coverage
Title insurance policies differ as to whether a property transferred to a trust or LLC will terminate the policy. The answer can be found in the language of each policy, which may or may not include trustees as insured parties. Accordingly, clients and practitioners should assume that transferring title risks terminating title insurance coverage.
For example, in the 2004 case of Kwok v. Transnation Title Insurance Co., a family transferred their property from an LLC to a trust before dissolving the LLC. The family later made a claim on their title insurance policy. The California Court of Appeals ruled that the transfer to the trust had voided their title insurance policy because the LLC was still named as the insured.
If a title insurance policy does not address this issue specifically, the client can generally obtain an endorsement naming a new or additional insured party (sometimes offered for free, often purchased for a relatively modest one-time fee) from their title insurance company.
3. Failing to Notify the Property Insurance Company
Once you have determined that the transfer is advisable from a mortgage and title insurance perspective, make sure to advise your clients to notify their property insurance company about the title transfer. That way, the trust and/or trustees can be added as additional insured parties if necessary. Property insurance, such as homeowner’s insurance, is important because it protects clients’ investments in their real property and their belongings in the case of loss or damage. Property insurance also provides liability coverage for the named insureds if injury or damage occurs on their property. Without ensuring continuity of coverage after a transfer, your clients risk losing these important protections provided by insurance. Preventing these issues can help you to avoid complications with your clients’ estate plans and malpractice exposure.
Learn More about Real Estate Title Issues
Issues with real estate abound and must be carefully considered, particularly when transferring ownership. Understanding how to structure ownership of residential real estate owned by nonresidents is equally important, as there can be a multitude of tax, estate planning, and reporting considerations for nonresidents who invest in US properties. To learn more about this complex topic, watch WealthCounsel’s on-demand, CLE-eligible webinar “Tax Considerations for Owners of US Real Property for Non-Residents.”
