A living trust is a legal document that states who you want to manage and distribute your assets if you're unable to do so, and who receives them when you pass away. Having one helps communicate your wishes so your loved ones aren't left guessing or dealing with the courts.
This is what Legal Zoom says about Living Trusts. What it does not say is that unless a living trust is set up properly, it can result in loss of the Texas homestead exemption as the Debtor found out in Case No. 18-50102, In re Steven Jeffrey Cyr (Bankr. W.D. Tex. 7/16/19) which can be found here.
What Happened
Dr. Steven J. Cyr is a doctor who retired from the Air Force with the rank of Lt. Colonel. In 2007, he and his wife purchased a home in San Antonio with a mortgage of $2.1 million. He also purchased a second property in 2017. On September 12, 2014, Dr. Cyr and his wife created a living trust and transferred their home into it by warranty deed. Dr. and Mrs. Cyr were the Trustmakers, trustees and beneficiaries of the living trust. However, Dr. Cyr resigned as a Trustee as of January 1, 2018.
On January 20, 2018, Dr. Cyr filed a petition under Chapter 7. Several parties objected to his homestead exemption. Additionally, there were adversary proceedings filed to avoid transfers, determine the dischargeability of a specific debt and dney discharge.
Judge Craig Gargotta conducted a four day trial concluding on March 7, 2019.
The Ruling
Judge Gargotta rejected the argument that the Cyrs had abandoned their homestead. Although Mrs. Cyr and their children moved out of the residence post-petition, Dr. Cyr never did. Even though a real estate agent created a brochure and video for sale of the property, the property was never actually marketed.
However, the Court found that the property lost its homestead status when it was transferred to the living trust without complying with Texas Property Code Sec. 41.0021.
Prior to 2009, there was a controversy over whether property transferred to a living trust could be claimed as homestead. In 2009, the Texas legislature sought to fix this problem by enacting Sec. 41.0021 which states that property transferred to a "qualifying trust" which is occupied by the owner as his residence would constitute the owner's homestead. A "qualifying trust" was defined as an express trust
First, Judge Gargotta found that the settlor did not have the right to revoke the trust without the consent of another person. Under the trust document, both of the settlors had to consent to revocation of the trust. Rather than interpreting the clause to mean that someone other than the settlors had to consent, Judge Gargotta found that the requirement for both parties to consent did not satisfy subsection (a)(1)(A).
The Trust also failed to include a provision allowing for an inter vivos general power of appointment over the property.
Finally, the trust document allowed the owners to occupy the property "rent free and without charge" but did not say that they could occupy the property at no cost as required by the statute. The problem is that Texas law has two definitions of a "qualifying trust." A qualifying trust under the Texas Tax Code is one in which the party may occupy the property rent free and without charge. Tex. Tax Code Sec. 11.13(j). However, the Property Code requires that the person be allowed to use the property without charge. Tex. Prop. Code Sec. 41.002(a)(1)(C). Judge Gargotta concluded that the Texas legislature must have meant something different by the two formulations and that therefore, the Tax Code language would not satisfy the requirements of the Property Code.
Thus, for lack of proper verbiage, the homestead exemption was lost.
Why The Opinion May Be Wrong or At Least Should Be Wrong
There are some reasons to believe that Judge Gargotta's ruling may be in error. Homesteads are favorites of the law. There was good law that transfers of property to a living trust did not forfeit homestead protection prior to the 2009 law. Additionally, Judge Gargotta's hyper-technical application of the statute seems contrary to the intent of the statute. (In giving my opinion, I am cognizant of the fact that Judge Gargotta has "Judge" before his name. As a result, his opinions carry legal force and mine are merely an appeal to the court of public opinion).
Under Texas law, where one person holds both legal and equitable title to a property, the estates are merged and the person holds the property free of trust. In re Vazquez, 2012 Bankr. LEXIS 642 (Bankr. W.D. Tex. 2012), aff'd. Lowe v. Vazquez, 2013 U.S. Dist. LEXIS 44271 (W.D. Tex. 2013). Unfortunately, here there were two trustees and two beneficiaries. However, it is not an outlandish argument to say that the community estate of the Cyrs held both legal and equitable title, therefore extinguishing the trust.
Prior to the Cyr decision, there was not any precedent interpreting Sec. 41.0021. Therefore, Judge Gargotta was free to interpret the text in a manner which harmonized both its text and purpose. The purpose was obviously to avoid loss of homestead protection when property was conveyed to a living trust.
I will acknowledge that the literal language of Sec.41.0021(a)(1)(A) says that a qualifying trust is one in which "a settlor or beneficiary" has the right to "revoke the trust without the consent of another person." This language seems to say that one person must be able to unilaterally terminate the trust. However, given the importance of the homestead exemption, I would read the phrase to say that no one other than another settlor or beneficiary is needed to terminate the trust.
Finally, I think that the phrases "rent free and without charge" and "at no cost" say the same thing. I don't think that whether someone gets to keep their homestead should depend on the slavish application of magic words.
Finally, what is the consequence of the homestead being found non-exempt? If both debtors had filed, the trustee could have exercised their power to revoke the trust. However, that could not be done because Mrs. Cyr did not file bankruptcy. So the property is owned by a trust rather than the estate. Under Texas law, creditors can reach the interest of a debtor in a self-settled trust. This means that the property contributed by the debtor is subject to claims of creditors. Shurley v. Texas Commerce Bank-Austin, N.A. (In re Shirley). 115 F.3d 333 (5th Cir. 1997). The debtor contributed an undivided one-half interest in the property to the trust. Thus, the trustee can only reach that undivided interest.
Avoiding the Problem
There is any easy solution to this problem. Never, ever, ever, ever transfer your homestead to a living trust. The advantage of a living trust is that it supposedly avoids the need to probate a will. However, probate in Texas is easy. If your client has already executed a living trust, revoke it prior to filing. The essence of a living trust is that it is freely revocable. Debtor's lawyers should always ask their client if they have conveyed their homestead to a living trust. It may be necessary to ask the question in several different ways. However, it is too important a step not to take.
Post-Script:
After the decision came down, the debtor filed a notice of appeal. The parties then filed a joint motion to have the case mediated before another federal Bankruptcy Judge. As a result, Mr. Cyr still has a chance to retain his home.
What Happened
Dr. Steven J. Cyr is a doctor who retired from the Air Force with the rank of Lt. Colonel. In 2007, he and his wife purchased a home in San Antonio with a mortgage of $2.1 million. He also purchased a second property in 2017. On September 12, 2014, Dr. Cyr and his wife created a living trust and transferred their home into it by warranty deed. Dr. and Mrs. Cyr were the Trustmakers, trustees and beneficiaries of the living trust. However, Dr. Cyr resigned as a Trustee as of January 1, 2018.
On January 20, 2018, Dr. Cyr filed a petition under Chapter 7. Several parties objected to his homestead exemption. Additionally, there were adversary proceedings filed to avoid transfers, determine the dischargeability of a specific debt and dney discharge.
Judge Craig Gargotta conducted a four day trial concluding on March 7, 2019.
The Ruling
Judge Gargotta rejected the argument that the Cyrs had abandoned their homestead. Although Mrs. Cyr and their children moved out of the residence post-petition, Dr. Cyr never did. Even though a real estate agent created a brochure and video for sale of the property, the property was never actually marketed.
However, the Court found that the property lost its homestead status when it was transferred to the living trust without complying with Texas Property Code Sec. 41.0021.
Prior to 2009, there was a controversy over whether property transferred to a living trust could be claimed as homestead. In 2009, the Texas legislature sought to fix this problem by enacting Sec. 41.0021 which states that property transferred to a "qualifying trust" which is occupied by the owner as his residence would constitute the owner's homestead. A "qualifying trust" was defined as an express trust
(1) in which the instrument or court order creating the trust provides that a settlor or beneficiary of the trust has the right to:
(A) revoke the trust without the consent of another person;
(B) exercise an inter vivos general power of appointment over the property that qualifies for the homestead exemption; or
(C) use and occupy the residential property as the settlor’s or beneficiary’s principal residence at no cost to the settlor or beneficiary, other than payment of taxes and other costs and expenses specified in the instrument or court order:
(i) for the life of the settlor or beneficiary;
(ii) for the shorter of the life of the settlor or beneficiary or a term of years specified in the instrument or court order; or
(iii) until the date the trust is revoked or terminated by an instrument or court order recorded in the real property records of the county in which the property is located and that describes the property with sufficient certainty to identify the property; and
(2) the trustee of which acquires the property in an instrument of title or under a court order that:
(A) describes the property with sufficient certainty to identify the property and the interest acquired; and
(B) is recorded in the real property records of the county in which the property is located.Subsection (a)(1) is written in the disjunctive so that only one of its three options need be satisfied. However, Judge Gargotta found that none of the provisions applied.
First, Judge Gargotta found that the settlor did not have the right to revoke the trust without the consent of another person. Under the trust document, both of the settlors had to consent to revocation of the trust. Rather than interpreting the clause to mean that someone other than the settlors had to consent, Judge Gargotta found that the requirement for both parties to consent did not satisfy subsection (a)(1)(A).
The Trust also failed to include a provision allowing for an inter vivos general power of appointment over the property.
Finally, the trust document allowed the owners to occupy the property "rent free and without charge" but did not say that they could occupy the property at no cost as required by the statute. The problem is that Texas law has two definitions of a "qualifying trust." A qualifying trust under the Texas Tax Code is one in which the party may occupy the property rent free and without charge. Tex. Tax Code Sec. 11.13(j). However, the Property Code requires that the person be allowed to use the property without charge. Tex. Prop. Code Sec. 41.002(a)(1)(C). Judge Gargotta concluded that the Texas legislature must have meant something different by the two formulations and that therefore, the Tax Code language would not satisfy the requirements of the Property Code.
Thus, for lack of proper verbiage, the homestead exemption was lost.
Why The Opinion May Be Wrong or At Least Should Be Wrong
There are some reasons to believe that Judge Gargotta's ruling may be in error. Homesteads are favorites of the law. There was good law that transfers of property to a living trust did not forfeit homestead protection prior to the 2009 law. Additionally, Judge Gargotta's hyper-technical application of the statute seems contrary to the intent of the statute. (In giving my opinion, I am cognizant of the fact that Judge Gargotta has "Judge" before his name. As a result, his opinions carry legal force and mine are merely an appeal to the court of public opinion).
Under Texas law, where one person holds both legal and equitable title to a property, the estates are merged and the person holds the property free of trust. In re Vazquez, 2012 Bankr. LEXIS 642 (Bankr. W.D. Tex. 2012), aff'd. Lowe v. Vazquez, 2013 U.S. Dist. LEXIS 44271 (W.D. Tex. 2013). Unfortunately, here there were two trustees and two beneficiaries. However, it is not an outlandish argument to say that the community estate of the Cyrs held both legal and equitable title, therefore extinguishing the trust.
Prior to the Cyr decision, there was not any precedent interpreting Sec. 41.0021. Therefore, Judge Gargotta was free to interpret the text in a manner which harmonized both its text and purpose. The purpose was obviously to avoid loss of homestead protection when property was conveyed to a living trust.
I will acknowledge that the literal language of Sec.41.0021(a)(1)(A) says that a qualifying trust is one in which "a settlor or beneficiary" has the right to "revoke the trust without the consent of another person." This language seems to say that one person must be able to unilaterally terminate the trust. However, given the importance of the homestead exemption, I would read the phrase to say that no one other than another settlor or beneficiary is needed to terminate the trust.
Finally, I think that the phrases "rent free and without charge" and "at no cost" say the same thing. I don't think that whether someone gets to keep their homestead should depend on the slavish application of magic words.
Finally, what is the consequence of the homestead being found non-exempt? If both debtors had filed, the trustee could have exercised their power to revoke the trust. However, that could not be done because Mrs. Cyr did not file bankruptcy. So the property is owned by a trust rather than the estate. Under Texas law, creditors can reach the interest of a debtor in a self-settled trust. This means that the property contributed by the debtor is subject to claims of creditors. Shurley v. Texas Commerce Bank-Austin, N.A. (In re Shirley). 115 F.3d 333 (5th Cir. 1997). The debtor contributed an undivided one-half interest in the property to the trust. Thus, the trustee can only reach that undivided interest.
Avoiding the Problem
There is any easy solution to this problem. Never, ever, ever, ever transfer your homestead to a living trust. The advantage of a living trust is that it supposedly avoids the need to probate a will. However, probate in Texas is easy. If your client has already executed a living trust, revoke it prior to filing. The essence of a living trust is that it is freely revocable. Debtor's lawyers should always ask their client if they have conveyed their homestead to a living trust. It may be necessary to ask the question in several different ways. However, it is too important a step not to take.
Post-Script:
After the decision came down, the debtor filed a notice of appeal. The parties then filed a joint motion to have the case mediated before another federal Bankruptcy Judge. As a result, Mr. Cyr still has a chance to retain his home.
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