WHAT IS A TRUST?
A trust is a three-part financial arrangement that holds assets for a beneficiary. Specifically, the trustor (or grantor) gives the trustee (an individual or an organization such as a bank or law firm) the right to hold title to property or assets for the benefit of a third party, the beneficiary.
WHAT IS AN LLC?
A limited liability company is a type of unincorporated association that is governed by an operating agreement. As a hybrid legal entity, it combines the characteristics of a corporation with a partnership or sole proprietorship: the members are not personally liable for the organization's debts or liabilities, and it provides the availability of pass-through income taxation, where the income of the entity is treated as the income of the investors or owners.
For a long time, co-op corporations tended to bar shareholders from transferring their shares to trusts, largely out of concern that the trustees would be less invested than an individual-owner in the well-being of the building. But times are changing.
“Those biases are out the window at this time,” says attorney Anita Rosenbloom, a partner at Stroock & Stroock & Lavan who was host of a recent webcast on estate planning and trust administration sponsored by the New York City Bar Association. Rosenbloom and other attending attorneys discussed how co-op and condo boards are becoming noticeably more comfortable with trust transfers as a growing number of co-op shareholders and condo unit-owners seek to take advantage of the tax and probate benefits they offer.
“Some buildings still don’t allow trust ownership,” Rosenbloom says. “But we can see it’s much more commonplace.” And not only with regard to transfers. “We are seeing numerous requests for trusts to purchase apartments,” she adds.
Attorney Peter Massa, a partner at Gallet Dreyer & Berkey, says: “In our firm we have roughly 10 of these transactions going on at any time.” He explains that trusts tend to be the more popular instrument for co-op owners, who have likely watched their investment mushroom in value and view a trust as a way to alleviate the expense and headaches of the probate process. Condos, on the other hand, which can be purchased by investors for use as rental properties and which usually don’t require board approval for trust tranfers, lend themselves better to limited liability company (LLC) transfers, a legal entity that also shields the principal(s) from tenant claims.
Either way, the management and board members must proceed with transfers in a manner that safeguards the co-op corporation or the condo association. “This is a situation where it’s okay for boards to accommodate their shareholders and do this,” says Massa, “but it’s not okay to do this without properly documenting it.”
Know the No-No’s
Perhaps most important, co-op boards, which possess the power to approve or disapprove transfers, must establish a policy and procedure that can be applied fairly and equally to all shareholders – because once the board approves one transfer, it will be hard to say no to the next request. Such a refusal could lead to a legal challenge.
“Boards really do have to be consistent, and the more objective reasons [you have], if you are going to reject someone, the better,” says Dale Degenshein, special counsel at Stroock & Stroock & Lavan. As a legal representative for co-ops and condos for more than 25 years, Degenshein has established a routine whenever she receives a transfer application. First, she recommends the board immediately obtain a retainer from the applicant for any legal costs, and she notifies the applicant exactly what will be required. This includes, among other things, a copy of the entire trust agreement (without redactions), an opinion letter by the trust attorney (to validate it), an occupancy agreement, and a personal guaranty from a guarantor “who should present financial assets to the board as if they were applying to purchase the apartment,” she says.
To avoid unnecessary legal expenses and wasted time, Degenshein also apprises applicants of the types of trusts the board won’t accept. These include Medicaid trusts, asset-protection trusts, and trusts made outside the United States.
“Those are absolute no-no’s from the start,” Degenshein says.
Fractional ownership is another situation that tends to elicit a collective groan from board members. Rosenbloom recalls a shareholder who wanted to establish a qualified personal residence trust that would allow her to continue living in the co-op apartment for a term – a common petition – except that, at the end of the term, the shareholder wanted the apartment subdivided into four separate personal residence trusts for four children, giving each a 25 percent ownership stake. “The board did not relish the idea,” says Rosenbloom, explaining that boards don’t want to deal with multiple owners for one unit and the possibilities for discord that it can engender.
Degenshein also recommends that management give these owners a heads-up regarding flip taxes. In some buildings, the flip tax isn’t applicablewhen the apartment is transferred to a spouse or a trust, while in others it is. “Take a look at it,” Degenshein advises. “You could be talking about a lot of money.”
Similarly, condo unit-owners who want to initiate a transfer may not realize that switching to an LLC will make them ineligible for the New York City co-op and condo tax abatement. (Trusts transfers can be eligible if the beneficiary of the trust resides in the apartment.) “That’s a big deal that sometimes people don’t realize until the end,” says Massa.
In Trusts We Trust
After Degenshein receives the documents, she reviews them for problems or legal impediments. Any so-called spendthrift provisions, for instance, will have to be amended as they relate to the co-op. In other words, the co-op has to be able to go after assets of the trust.
She also reviews past actions involving the shareholder to ensure that everything was handled properly. For instance, if the shareholder has made an alteration or instituted a leasing agreement to use common space, such as a portion of a roof or hallway, “we make sure those are assigned, along with all the other documents,” she says. “You don’t want to lose that chain of title.”
Since the stability of co-ops depends on having reliable, responsible, and reasonable shareholders, boards are primarily concerned about two things: who will pay the maintenance and who will reside in the apartment? To ensure that the maintenance gets paid, boards usually require a personal guarantee from the applicant – “to make sure someone is personally on the hook,” says Massa. They also request escrow money – equal to one or two years of maintenance – to alleviate further financial risk.
In the case of a prospective buyer looking to make an initial co-op purchase as a trust, says Massa, “we suggest that the board also review the financials of the principals, and not just the trust, to ensure that the principals would be accepted as anyone else would, and get guarantees from them.”
As for who gets to reside in the apartment – and to make sure that no one starts using it as, say, a short-term hotel – the lawyers require an agreement that limits occupancy, in the case of a co-op, to whoever is board-approved. With condos, the principals are also expected to sign a binding occupancy agreement stating who will be living there.
Then there are other details that Massa recommends for his clients, including getting a proxy for whoever is residing in the apartment to help guarantee that the board can meet the required quorum to pass co-op and condo measures. And since banks usually inquire about the percentage of owner-occupied apartments in a building when evaluating whether to offer loans to individual apartments, Massa suggests that boards maintain owner-occupancy levels that will continue to generate bank lending.
Massa and Degenshein are lately seeing more requests for trust transfers, both from New Yorkers who bought during the co-op conversion boom of the 1980s, and even in buildings not considered high-end. “You have a lot of people who didn’t spend a ton of money for their apartment initially, but now it’s worth $2 million, and they have to figure out what’s going to happen to them,” says Massa. “So it’s a much more popular vehicle right now as the prime co-op population is getting a little older.”
Adds Degenshein, “All I see flying across my emails is trust, trust, trust.”