An article circulating amongst real estate syndicates, investor groups, and developers purports that a Irrevocable Trust and that not a Limited Liability Company (LLC) is the ideal legal entity type to hold real estate investments. For the quick answer, generally LLCs are the ideal entity type to hold real estate investments; the law dictates that no two parcels are identical, and so it follows that every real estate investment is different, therefore some real estate investments are suited for Irrevocable Trusts. There are many investment entities that are suitable for investment including Limited Partnerships, Limited Liability Companies, and Corporations.

Real Estate Investment Trust (REIT) (semi-technical reduced for complexity, skim if necessary)
Some Irrevocable Trusts are REITs but not all REITs are trusts (irrevocable or otherwise). Internal Revenue Code (IRC) section 856 defines REITs as a “corporation, trust, or association” which is:

• managed by trustees or directors;
• beneficial ownership in the REIT is transferrable;
• would be taxable as a domestic corporation if not for this section (26 USC § 856);
• is not: (a) a financial institution described in (26 USC § 582(c)(2)): a bank or foreign ‘bank’; cooperative and mutual banks; licensed § 301 small business investment company (SBICs) (see Small Business Investment Act of 1958 for private equity and venture capital LLCs or LPs as amended post 2005); Business Development Corporation (see below bold titled); or (b) insurance company (see 26 USC Chapter 1, Subchapter L).
• ownership is held by 100 or more persons;
• (through reasonable diligence) is assumed to be not closely held under 26 USC § 542 meaning greater than 50% of ownership is held by 5 or less individuals; and,
• meets all 26 USC § 856(c) limitations, REITs must comply with all of the following:
  1. REIT election has not been terminated or revoked (see 26 USC § 856(g));
  2. (January 1, 1980 onward) 95% of its gross income is derived from: dividends, interest (see (G)(i)-(ii)), rents, sale of securities and real property (excluding 26 USC 1221(a)(1)), tax refunds, foreclosure income and gains, allowable transactions under 26 USC § 857(b)(6) (prohibited transactions), first year mineral royalties;
  3. at least 75% of its income is derived from: rents, interest (from real property mortgage) and (see (G)(i)-(ii)), sale of property (excluding 26 USC 1221(a)(1)), dividends, tax refunds, foreclosure income and gains, allowable transactions under 26 USC § 857(b)(6) (prohibited transactions), qualified temporary investment income; and,
  4. at least 75% of assets is in real estate, cash, account receivables, government securities; and not more than 25% is in other securities OR taxable REIT subsidiaries, EXCEPT no more than 5% of its total asset securities in any one issuer, the REIT does not hold more than 10% in any one issuer, and the REIT does not hold more than 10% of outstanding value of one issuer…

Business Development Corporation is a corporation created pursuant to State law “…for purposes of promoting, maintaining, and assisting the economy and industry within…” the “…State by making loans to be used in trades and businesses which would generally not be made by banks within…” the “State in the ordinary course of their business (except on the basis of a partial participation), and which is operated primarily for such purposes” (26 USC § 582(c)(2)(B)).

Even by skimming the above-summarized statute it should be obvious REIT should not be confused with a form of Trust or Corporation (that defeats one misconception).

Business Entities
A business entity is first (a) separate from an individual (legal personality), second (b) suited for business activity, third (c) it has more favorable taxation than several individuals, fourth (d) it has favorable liability protection for the torts of the entity, and five (e) ownership is generally transferable to another person.

Trust Entities
A trust entity is first (a) fiduciary relationship (duty to manage, invest, safeguard, and administer trust assets and income) in which the trustee(s) hold legal title for the benefit of designated beneficiaries who hold equitable title, second (b) may have favorable tax treatment compared with probate assets (think will vs. trust), third (c) is centered around a particular asset or assets owned at one time by the settlor (person who sets up the trust sometimes known as the grantor).

Why a trust may not be suitable for doing business.

• It is assumed that if the sole-Trustees are also listed as sole-beneficiaries, then legal and equitable title merge and the trust disappears (no trust exists) MCL 700.7402(1)(e). Someone (beneficiary) must exist to hold the trustee accountable to carry out the terms of the trust, and the same person cannot owe those duties to him or herself. However, the settlor can be the only beneficiary as long as the settlor is also not the only trustee.
• Trustees may only leave the administration of the trust by (i) providing 28 days notice, or (ii) through court approval (MCL 700.7705).
• Trustees may be removed if there is a serious breach of trust, lack of cooperation amongst co-trustees, persistent failure to administer the trust effectively, or substantial change of circumstances where removal of the trustee is in the best interest of all beneficiaries (MCL 700.7706). It is important to note there is no provision for payment to a removed trustee; in business if an owner is ejected he or she must receive a return on their interest in the business.
• Trustees are disallowed from following the purpose of the trust. The trust will fail if the purpose is to evade settlor’s creditors (see MCL 700.7404 for more information on trust purpose).
• An irrevocable trust without a spendthrift provision will allow creditors to reach the beneficiaries interest through garnishment or attachment (effectively defeating the only advantage a trust might have over a standard business entity). (see MCL 700.7502 for more on spendthrift and Fornell v. Fornell Equipment, Inc., 390 Mich. 540 (1973)). However, once the distribution has been made, the money is no longer protected MCL 700.7502(3) (procedurally creditors must move FAST after disbursement for obvious reasons).
• Property owners are not allowed to transfer assets (via spendthrift trust) for the property owner’s benefit to avoid creditors’ reach. Any interest retained by the settlor in any asset may be reached by the creditor in full. (see MCL 700.7506(1)(c) for more on settlor-beneficiary interests).
• Michigan disallows discretionary spendthrift trusts, whereby the trustee has complete discretion to disburse trust income to a class of beneficiaries (used to evade creditors). (see MCL 700.7505 for nuance in language of ‘pure discretion’).
• If more than 1 person or entity contributed to the trust, they are all settlors (MCL 700.7506(2)) and all retained interests may be reached.
• Additionally since settlors, beneficiaries, and trustees are typically individuals, unique situations arise in Michigan around dowery, divorce, and other familial legal actions.

Under most circumstances, the best method of administering and planning a real estate investment (or any other type of investment) is to incorporate under a business entity statute. The second step is to then place your personal assets into a trust revocable or irrevocable depending upon your needs. Speak with your trusted counselor for more information, it is important to explore new ideas and convey your intentions accurately to your lawyer.