Drawbacks of a Living Trust

Before you make a living trust, you should know the downsides.

A living trust does have unique problems and complications. Most people think the benefits outweigh the drawbacks, but before you make Nolo’s Online Trust, you should be aware of them.

Paperwork

Setting up a living trust isn't difficult or expensive, but it requires some paperwork. The first step is to create and print out a trust document, which you should sign in front of a notary public. That's no harder than making a will.

There is, however, one more essential step to making a living trust effective: You must make sure that ownership of all the property you listed in the trust document is legally transferred to you as trustee of the trust.

If an item of property doesn't have a title (ownership) document, you can simply list it on a document called an Assignment of Property. (Nolo’s Online Trust generates this document automatically.) Most books, furniture, electronics, jewelry, appliances, musical instruments and many other kinds of property can be handled this way.

But if an item has a title document -- real estate, stocks, mutual funds, bonds, money market accounts or vehicles, for example -- you must change the title document to show that the property is held in trust. For example, if you want to put your house into your living trust, you must prepare and sign a new deed, transferring ownership to you as trustee of the trust (or, in Colorado, to the trust itself). Transferring Property to the Trust explains how.

Record Keeping

After a revocable living trust is created, little day-to-day record keeping is required. No separate income tax records or returns are necessary as long as you are both the grantor and the trustee. (IRS Reg. § 1.671-4.) Income from property held in the living trust is reported on your personal income tax return.

You must keep written records whenever you transfer property to or from the trust, which isn't difficult unless you transfer a lot of property in and out of the trust. Living With Your Living Trust discusses transferring property in and out of your living trust.

EXAMPLE: Monica and David Fielding put their house in a living trust to avoid probate, but later decide to sell it. In the real estate contract and deed transferring ownership to the new owners, Monica and David sign their names "as trustees of the Monica and David Fielding Revocable Living Trust."

Transfer Taxes

In most states, transfers of real estate to revocable living trusts are exempt from transfer taxes that are usually imposed on real estate transfers. But in a few states, transferring real estate to your living trust could trigger a tax. (See Real Estate in Transferring Property to the Trust.)

Difficulty Refinancing Trust Property

Because legal title to trust real estate is held in the name of the trustee, a few banks and title companies may balk if you want to refinance it. They should be sufficiently reassured if you show them a copy of your trust document, which specifically gives you, as trustee, the power to borrow against trust property.

In the unlikely event you can't convince an uncooperative lender to deal with you in your capacity as trustee, you'll have to find another lender (which shouldn't be hard) or transfer the property out of the trust and back into your name. Later, after you refinance, you can transfer it back into the living trust.

No Cutoff of Creditors' Claims

Most people don't worry that after their death, creditors will try to collect large debts from property in the estate. In most situations, the surviving relatives simply pay the valid debts, such as outstanding bills, taxes and last illness and funeral expenses. But if you are concerned about the possibility of large claims, you may want to let your property go through probate instead of a living trust.

If your property goes through probate, creditors have only a certain amount of time to file claims against your estate. A creditor who was properly notified of the probate court proceeding cannot file a claim after the period -- about six months, in most states -- expires.

EXAMPLE: Elaine is a real estate investor with a good-sized portfolio of property. She has many creditors and is sometimes named in lawsuits. It might be to her advantage to have assets go through a probate, which cuts off the claims of creditors who are properly notified of the probate proceeding.

On the other hand, when property isn't probated, creditors still have the right to be paid (if the debt is valid) from the property. There is no formal claim procedure, however. The creditor may not know who inherited the deceased debtor's property, and once the property is found, the creditor may have to file a lawsuit, which may not be worth the time and expense.

If you want to take advantage of probate's creditor cutoff, you must let all your property pass through probate. If not, there's a good chance the creditor could still sue (even after the probate claim cutoff) and try to collect from the property that didn't go through probate and passed instead through your living trust.

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