Why You Shouldn’t Put a Rental Property Directly in a Revocable Living Trust

A revocable living trust is a popular estate planning tool that allows an individual to manage their assets during their lifetime and to transfer those assets to their beneficiaries after death without going through probate. While a revocable living trust offers many benefits, it is not always the right choice for holding all types of assets—particularly rental properties. When it comes to holding rental properties in a revocable living trust, there are risks that investors should carefully consider.

One of the primary disadvantages of holding rental properties in a revocable living trust is the lack of asset protection. A revocable living trust does not shield assets from lawsuits or creditors. Since the trust is revocable, the person who created the trust (the grantor) still technically owns the property. If a lawsuit arises, such as from a tenant injury or property damage, the properties in the trust are still vulnerable to legal action. Creditors can go after the assets in the trust just as they could if the properties were owned directly by the individual.

A revocable living trust is an excellent vehicle for managing certain types of assets. Liquid assets like checking and savings accounts are easily managed within a trust and allow for seamless distribution after death. Stocks, bonds, and other investments can be placed in a trust to avoid probate and ensure the assets pass to beneficiaries efficiently. Primary residences and vacation homes can be placed in a revocable living trust to facilitate easy transfer upon death. Valuable personal items such as jewelry, art, and heirlooms can be placed in the trust.

It’s important to remember that A revocable living trust does not provide any form of asset protection from lawsuits. Since the trust is revocable, the individual who created it (the grantor) maintains control over the assets. This means that creditors, plaintiffs, or anyone pursuing legal action can still target the assets held in the trust. This lack of protection is one of the key reasons why holding rental properties in a revocable living trust can be risky.

This reminds me of a story about an Investor friend of mine, Steve.

Steve had spent years building his real estate portfolio. He owned several rental properties in multiple cities, and his rental income was a primary source of his wealth. As Steve grew older, he decided to make his estate planning easier by putting all his properties into a revocable living trust. He believed this would streamline the transfer of assets to his children when he passed away and avoid the hassle of probate.

Steve’s trust was well-structured. It held his primary residence, his vacation property, and all of his rental properties. He felt confident knowing that when he passed, his family would inherit everything smoothly.

One day, Steve received a call from his property management team. One of his tenants, an elderly woman, had tripped on a cracked sidewalk outside her rental unit and sustained an injury. She sued Steve, claiming negligence for not maintaining the property in a safe condition.

Unfortunately for Steve, his property was a prime target. The lawsuit quickly escalated, and the damage claims grew larger. Even though Steve had insurance, the costs of legal fees and potential settlements started to add up. Worse yet, because all of his properties were held in his revocable living trust, they were now exposed to the lawsuit. Since the trust was revocable, Steve’s personal assets were still considered fair game for creditors.

As the lawsuit progressed, Steve realized that he had made a critical mistake by placing all of his rental properties in his trust. His legal team explained that the trust offered no asset protection, and the properties were vulnerable to any judgment resulting from the lawsuit. Steve’s tenants knew that he owned multiple properties in different locations, and now the entire portfolio was at risk.

The case was ultimately settled for a substantial amount, but Steve’s assets had been significantly affected. Not only did he lose a portion of his rental income from the affected property, but the legal expenses and settlement reduced the value of his trust’s assets. The other properties in the trust, which had been financially stable before the lawsuit, were now all tied up in the legal battle.

Steve learned the hard way that a revocable living trust, while useful for avoiding probate, does not offer the asset protection needed for holding rental properties. In the end, he had to restructure his estate plan and move his rental properties into a smarter structure that would carry less risk.

While a revocable living trust is a powerful tool for estate planning, it is not the best option for holding rental properties. As Steve’s story illustrates, holding rental properties in a revocable living trust can expose an investor’s entire portfolio to risk, which could have been mitigated with a more appropriate asset protection strategy.

Don’t be like Steve.

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DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.