Understanding the Trust Exception to Real Estate Disclosures

Understanding the Trust Exception to Real Estate Disclosures

By: D. Keith Dunnagan, Esq.

March 9, 2021

The scenario starts off innocently enough:

Investor forms a trust and buys rental properties. Maybe they pay cash, maybe they finance, but they take the property at the time of closing in the name of their trust. The investor never owns the property in their name, they never live there, they simply operate it as a rental for a period of time. Then the market or life circumstances make it advisable or necessary to sell that rental property. So they hire a real estate professional to help them navigate a sale. That agent looks at the transaction and says “hey, this is a trust owned property and sale, it’s exempt from disclosures and provides the exemption forms to the buyer.” The question – is it really an exempt transaction? There is some homework to be done.

California Civil Code 1102 (CC 1102) creates the obligation that sellers provide disclosures to the buyer related to material defects that are likely to affect price or desirability. To complete these disclosures the California Assembly provided a standard form in California Civil Code Section 1102.6. This standard form has been reduced to the Transfer Disclosure Statement (TDS) that many brokers/agents use during the purchase and sale of residential real estate.

The policy of the statute is to make sure that disclosures are given to buyers during the purchase of the home. The RPA clearly states that transactions involving the purchase and sale of a home are “As Is” transactions, meaning that generally the seller is not providing any warranties with the transaction, and that the buyer gets the home in the condition it is in at the time of closing. However, homes are uniquely situated in that often times, the buyer has inferior knowledge as to the condition of the home and is not in a position to discover those defects. After all, destructive testing (ie. opening up walls) is expensive and most sellers are not going to let a random buyer put a hole in the wall to investigate potential defects.

Consequently, California enacted the laws contained in Civil Code 1102 to require Sellers to complete the TDS and provide this information to buyers. In doing so, the Assembly, stated that these disclosures are so important that parties to a transaction cannot waive the disclosures and any attempted waiver would be “void as against public policy.” (CA Civ. Code 1102(c)).

Further, in this statute the Assembly limited the use of the “As Is” clause as interpreted in Loughrin v. Superior Court. Meaning that although the parties agreed that the property is sold in in its “as is” condition, the clause does not insulate a seller from a misrepresentation contained in the disclosures. In 1993 the Loughrin decision the Court stated that a “knowing and explicit waiver of the benefits of section 1102 et seq. can be effective.” The Assembly, concerned with this decision, later amended the statute and prohibited any waivers under Loughrin.

The legislature has spoken loudly and consistently on the importance of these disclosures to buyers. Consequently, it is important in understanding how the exceptions work; because, while the disclosures are required, there are some transactions where the disclosure is not required.

The most common exclusion is dealing with the Trust sale. A sale of real property owned by a trust is exempt from the disclosure requirements under the statute. (CA CC 1102.2(d)). However, the exemption is not absolute.

There are two parts to the exemption. First, you must identify whether the transaction is a covered transaction. The first sentence of CC 1102.2(d) states that “Sales or transfers by a fiduciary (think trustee) in the course of the administration of a trust, guardianship, conservatorship, or decedent’s estate.” Here, the statute is specifically limits the exemption to these those transactions fitting within the specified exemption. If the trust is the owner of the property, but the transaction does not fit within one of the four identified transactions above, then the seller must complete the disclosure. Most try to claim that the sale is part of the broad concept of administration, however, trust administration is generally defined as the management of the trust for the benefit of the beneficiaries after the trustor or settlor (the individual or individuals that created the trust) are deceased.

If the transaction is a covered transaction then we look at the second part of the statute. The second part of the statute states that if the exemption is to be used it cannot be used by the trustee if the trustee is a natural person, the trust is revocable, and is a former owner of the property or lived in the property. If these elements are not met, then the exemption cannot be used.

So again, referring back to our scenario does this trustee have an obligation to complete the disclosures (TDS) required under CC 1102. While the trustee never lived in the property, never had title in their own name only in their capacity as the trustee, is a natural person and the trust is revocable, the transaction does not appear to be exempt from 1102 disclosures. The reason is that under the law, the transaction is only exempt if the trust transaction is for administration, guardianship, conservatorship or a sale from a decedent’s estate. These transaction types did not occur. The law does not provide a work around.

One practical thing to consider/remember – most of the time when someone is buying a property, especially, if it is financed, the property will be taken in their name and then transferred into the trust later. If that happens, then the seller/trustee does not meet all of the requirements in the second sentence because they did own it, albeit for a brief period of time.

It is easy to get tripped up and think that trustee checks all the boxes in the second sentence, but you must remember that if the transaction itself is not exempt, then the second sentence does not matter.

Before jumping to the conclusion that the transaction is exempt because it is owned by a trust — ask some questions. Did the trustee ever own the property? Did the trustee live in the property? Did they live there within the last year? Is this a covered transaction?

When it comes to the law of disclosures, the law can be complex, and the Assembly has modified the disclosure statutes in 2018, 2019 and 2020. If you have questions related to disclosure obligations you should seek competent legal counsel to assist you. The liability exposure can be significant and with an attorneys fee clause in the RPA.

If you would like a consultation with us, please contact our office at 916-966-2260.

The information presented in this article is not to be taken as legal advice. Every situation is different. If you are facing a legal issue of any kind, get competent legal advice in your state immediately so that you can determine your best options.

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