Real estate guru Bill Gatten has an approach he calls a PACTrust. I attended a presentation where he described it at a free seminar. He says the PACTrust lets you:
- ignore due-on-sale clauses
- buy for nothing down
- avoid credit checks
- have bulletproof asset protection
- get all the benefits of wraps, land contracts, lease options, and equity sharing without the disadvantages of those financing techniques
- protects seller from buyer default
- simplifies closing
- eliminates management
- eliminates maintenance
- has no credit risk
For starters, this violates the too-good-to-be-true rule. As a matter of fact, it is probably the most extreme violation of the too-good-to-be-true rule I have ever seen in real estate.
Be sure to read the statement about the Gatten Trust published by the Ohio government Division of Real Estate and Professional Licensing in their summer 2007 newsletter. You can see the redacted version at the Ohio government Web site at http://www.com.state.oh.us/real/documents/2007Summer.pdf. I obtained an unredacted copy of the statement. You can see the partially unredacted version, which has Bill Gatten’s full name, at my Web site at www.johntreed.com/Ohioaction.html.
What is the PACTrust?
I am not sure the following is an exact description of the PACTrust. Normally, I would make sure its exact. I got enough so youll get the idea. In order to make my analysis precise, I asked Gatten to send me a copy of his book or whatever form he sells this in. He refused.
- Motivated seller deeds property into a living, revocable, beneficiary-directed land trust. The seller becomes the beneficiary. A third party becomes the trustee.
- Investor acquires property for no money down by becoming co-beneficiary with seller. Both co-beneficiaries have power of direction over trustee.
- Trustee hires property manager.
- Investor, hereinafter referred to as second co-beneficiary, leases property from land trust.
- Second co-beneficiary pays rent to property manager who pays all expenses and mortgage.
- Second co-beneficiary markets property as an equity-sharing deal.
- The person we would normally call a tenant or home buyer becomes the third co-beneficiary, but he has no power to direct the trustee. He subleases the property from the second co-beneficiary and has an agreement to split any appreciation 50-50 with the second co-beneficiary
One of my rules is that simple is better than complex. This is one of the most complex real estate deals I have ever heard of. And the other similarly complex deals all involved zillion-dollar, high-rise office buildings. On those deals, there is enough money to afford lawyers to work all this out. But in single-family home transactions, you cant afford to hire a battery of high-powered lawyers to make sure this hyper complex deal is legit. Plus, the other parties and lenders would each have to hire a similar battery of high-powered lawyers. Not gonna happen in a house deal.
Economics of the deal
The supposed economics of the deal are that Gattens investor is buying subject to the existing mortgage and putting nothing down. Gattens sandwich lease payments are relatively low. His subtenant pays an above-market rent for reasons similar to why a lease-option tenant pays above market: credit toward purchase price, share of appreciation, etc.
There is no find a need and fill it in this technique. This is find two suckersthe seller and tenant/buyer. Then get the sucker seller to sell cheap and get the sucker tenant to overpay. How is this accomplished? By bamboozling them with complexity and fast talk. This is the real estate equivalent of a shell game.
I assume that most of my readers are sophisticated enough to see through this, but because it involves so many techniques and Gatten says he has thousands of followers, I will devote enough space to analyze it.
Gatten says he sells the tax write-offs to the tenant for, say, $250/month extra rent. By tax write-offs, he means homeowner property tax and mortgage interest deductions.
He did not make it clear, but I will, that if the tenant gets the homeowner tax deductions, the investor may not depreciate the property. In the eyes of both the law and logic, there only can be one owner at a time. (If you comply with the requirements of IRC §280A, you can share the deductions proportionately in an equity-sharing arrangement. Whether or not a PACTrust, with all its extraneous complications, would be considered a Shared equity financing arrangement by tax-law authorities is questionable.) Mr. Gatten is welcome to ask for an IRS Letter Ruling on his PACTRust. As far as I know, he has not done so.
Also, I do not know that Mr. Gatten has the legal right to sell the tax deductions to the tenant. The Internal Revenue Code prescribes who gets the tax deductions. Section 163(h)(3) says you can deduct interest on acquisition indebtedness on any qualified residence of the taxpayer. There is a general principle of law that the owner of a piece of real estate is the guy who has the benefits and burdens of ownership. If multiple people have various benefits and burdens, the guy with the most is considered the owner. I am not sure Gatten is leaving the tenant enough of the benefits of ownership to convince the courts that the guy deducting the mortgage interest is really the owner. Also, to deduct interest, you must be the borrower. I am not sure Gattens tenant is the borrower for legal purposes.
To deduct the property taxes, you must be the owner. Imagine trying to prove that to an IRS auditor in this deal.
Gatten says the 2nd co-beneficiary can not only evict the 3rd co-beneficiary in the event of late payment of the rent, but that the eviction is much faster than the normal eviction. He claims he and his followers have done this many times.
I dont see how. You cant tell the IRS the 3rd co-beneficiary is an owner when it comes to deducting taxes and interest, then claim he is a mere tenant for eviction purposes. If he is enough of an owner for tax and mortgage interest deductions, and/or if his contract gives him equity, he must either be judicially foreclosed or forced out by a partition lawsuit.
You can evict someone out of his pure leasehold estate. But you cannot evict someone out of his equity. As a practical matter, you might be able to get away with this at times because of lack of sophistication on the part of the tenants, justices of the peace, and so on. But I doubt that an informed application of the pertinent laws would permit an eviction.
Gatten discussed, at great length, the standard due-on-sale clause that is in almost all mortgages, and why his PACTrust gets around it. He spouted court decision and statute citations as he went. But the fact that you mention the laws does not prove that your approach complies with them. Or that you are taking into account pertinent adverse decisions.
In his excessive quoting of statutes, court decisions, and regulations, Gatten reminds me of the kooks who have long, convoluted, citation-laden explanations of why the federal income tax in unconstitutional. He also brings to mind Shakespeares line in Hamlet: The lady does protest too much, methinks.
Why still due-on-sale
For a detailed explanation of why you cannot get around due-on-sale clauses, see my Web article at www. johntreed.com/dueonsale.html.
Heres a condensed version. The de la Cuesta U.S. Supreme Court decision (458 U.S. 156), the Garn-St. Germain Depository Institutions Act of 1982, and the ensuing Federal Home Loan Bank Board (now Office of Thrift Supervision) regulations say that due-on-sale clauses are enforceable.
Futhermore, the court decision, Garn Act and regulations are quite comprehensive and airtight. The name due-on-sale is a misnomer. The mortgage is really due on almost any transaction other than a straight lease with a three-years or shorter term.
Living trust exception
Theres a pertinent exception in the Garn Act and the regulations. You dont have to pay off the mortgage if you deed your home to a living trust. People do this to avoid probate.
But the exception makes it abundantly clear that you can only do this if you continue to be the owner of the property in all respects except the name on the deed. In other words, the only circumstance in which deeding a property to a trust does not trigger a due-on-sale clause is when it is merely for the purpose of avoiding probate.
Bill Gatten, and a number of other gurus who say they can tell you how to get around due-on-sale clauses, repeatedly tell you that their approach does not violate the due-on-sale clause. Thats a Freudian slip.
There is no such thing as a violation of a due-on-sale clause. A due-on-sale clause is not a promise by the borrower to refrain from selling, etc. The word that I use is trigger. There is probably a fancier legal term.
Due-on-sale clauses say that if the borrower does any of the things listed in the clause, the lender then has the option to make the borrower pay off the entire loan (call) immediately. You are not breaking the law or the contract if you do one of the due-on-sale-triggering transactions. But you may be violating the law if you conceal the transaction from the lender or deceive the lender regarding the transaction.
The first step in the PACTrust is deeding the property to a revocable living trust. To do that, you must tell the lender you are doing this for the permissible purpose under the Garn Act and related regulations. Since you are really doing it for PACTrust purposes, such a representation to the lender would arguably be fraud or concealment of a material fact or both.
Those are felonies. Do it twice in a ten-year period and it is arguably racketeering, a felony with a bounty-hunter triple-damages civil provision.
Gatten says due-on-sale clauses are rarely enforced. True. That is a major scandal. I called the Office of Thrift Supervision to ask about their enforcement of the regulations. Federal agencies typically publish annual statistics showing their enforcement actions. The attorney to whom I spoke asked me why OTS should care about this.
When I got over my astonishment, I explained to her that OTS had promulgated the pertinent regulations and was the agency in charge of enforcing them. She then said no comment.
Lack of enforcement enables gurus
The fact that due-on-sale clauses are rarely enforced has allowed a whole industry of gurus to arise selling get-around-due-on-sale-clause techniques. The fact is that putting garlic in a bag around your neck would probably give you the same protection from due-on-sale clause enforcement as a PACTrust or a lease option or any of the other guru tricks.
The fact that such garlic users would not be foreclosed proves nothing, just like a lack of enforcement against PACTrusts proves nothing about their standing in due-on-sale law. If and when lenders start enforcing due-on-sale clauses, and PACTrust users win the lawsuits, Ill agree that PACTrusts enable you to get around due-on-sale clauses. Until then, I think there is no chance that an informed court would prevent a lender from calling the loan as a result of a PACTrust transaction.
Take your chances
If you want to trigger a due-on-sale clause and rely on the lack of enforcement to protect you from having to pay off the loan, you have the right to do so. But as I writer, I cannot advocate that. It may be that something will cause all lenders to start enforcing due-on-sale clauses tomorrow.
If you have a large real-estate portfolio with only one property where the due-on-sale clause has been triggered, you can probably survive. But many followers of the get-around-due-on-sale-clause gurus have their entire portfolio in technical default because of universal use of unauthorized subject-to purchases. They would have great difficulty paying off all those loans at once.
During the speech I heard, Gatten said his PACTrust was bullet proof and armor plated for asset protection from creditors.
My general impression is that almost no asset protection scheme is bulletproof. For asset protection, I recommend the Florida and Texas bankruptcy homestead exemptions and laws like the one that lets OJ keep his pension. All the other stuff, like family limited partnerships, offshore trusts, and so forth, have some horror stories involving creditor penetration.
Gatten referred to the need to avoid fraudulent transfer in anticipation of bankruptcy, but as with his other acknowledgments of various laws, merely mentioning a law does not eliminate its problems regarding the PACTrust. The law prohibits transferring assets to another person or entity for less than market value when you expect that you may become insolvent in the forseeable future.
When you fail to pay your creditors in full, you are likely to be questioned by them under oath as to your assets. Gatten says if you do his PACTrust, you can answer No to the question, Do you own any real estate? His rationale is that the land trust owns it, not you. Thats Clintonesque.
While it is true, as Clinton protested, that you are not supposed to go beyond the question in a deposition answer, that sort of narrow, legalistic approach is one that only a lawyer could love. If you admired Clintons quibbling about the definition of is or Al Gores no controlling legal authority, youll love the PACTrust.
But if I were an attorney opposing you, I would make you look like a dishonest jerk to the judge or jury if I caught you parsing words to conceal assets. I would first give you a chance to play that game under oath, then I would hit you with questions that were bulletproof, if youll pardon the expression. Questions like, Are you a beneficiary of any trust? Law libraries have excellent checklists of questions to ask of debtors to cut through efforts to hide assets in trusts and such.
Gatten says that the use of the word a instead of the in the Garn-St. Germain discussion of beneficiaries creates the loophole through which he drives his PACTrust truck. I doubt any court will jeopardize billions of taxpayer-insured deposits, because a laymen like Gatten points to the word a and says, Aha! Indeed, I have no idea why the use of the word a has any importance at all.
Tangling your finances with an innocent party
One theory of asset protection relies on the laws reluctance to harm an innocent party in order to let creditors collect from a debtor. For example, Joe and Bob own a bakery. Joe gets into financial difficulty. Creditors want to sell off Joes interest in the bakery to get their money. But because of the going-concern value of a bakery, that would hurt Bob, who owes no money to the creditors.
Profits and salary
The law allows a charging order which confiscates and gives to the creditors Joes share of any profit distributions. Asset-protection guys say, No problem, We just wont distribute any profits. But what will Bob and his family say about that? Their profits are imprisoned in the bakery because Uncle Joe is a deadbeat.
Joe can take out a reasonable salary, although, in most states, his creditors would garnish it.
Gattens three co-beneficiaries appear to be a way to try to use the innocent-party defense to stymie creditors. A problem arises when the underlying asset has relatively little going-concern value. Bakeries lose sales and values when they shut down and reopen in another location half as big. Income properties, on the other hand, suffer little or no such loss of value as a result of being split up.
Confused mind says no
There is an old saying that a confused mind says no. If you go at a competent seller or agent with a PACTrust offer, they will probably throw you out of their office.
Investor Bill Snipes said he once got shot down just trying to buy a house in a living trust for pure probate-avoiding purposes. The lender said what you are doing may be fine, but we cannot afford to have our attorney review the trust, so your application is rejected merely because of its sheer complexity.
Expensive legal research that only produces questions
A competent seller who tried to accommodate a PACTrust buyer would have his attorney review the documents. There probably are few, if any, attorneys, with PACTrust experience. Accordingly, they would have to do an extraordinary amount of research and would have to hire other attorneys to help because the PACTrust involves numerous legal specialties.
Although there are many statutes and court decisions about the various individual components of the PACTrust, I doubt there are any widely applicable statutes or court decisions on the whole PACTrust conglomeration in one transaction.
Furthermore, consumer law is very different from business law. The vast majority of statutes and court cases pertaining to complex uses of trusts, options, and so forth, involve commercial transactions where all parties are sophisticated businesspeople.
Lease options offer a simpler example of the issues. The law of consumer leases is well established. Option law is somewhat well established, but almost all the cases involve commercial transactions.
Plus, a lease option is neither a lease nor an option and is probably a totally different thing entirelya land contract sale. Courts arrive at this conclusion using the legal doctrine of substance over form. And that does not take into account how courts would reconstrue the pertinent legal authorities to take into account the various protections given to consumers in transactions with sophisticated businesspeople.
Even after extensive research, an attorney would conclude that he does not know how a PACTrust would be treated in a legal dispute because of the lack of court decisions on such an arrangement and his inability to apply existing law to the PACTrust because of its complex, hybrid nature.
Gatten calls his PACTrust a novel use of the Illinois land trust. Novelty is generally a good thing. But not in law.
When you say something is legal, you are saying that it conforms to a statute or to court decisions, regulations, or other similar legal authorities. But there is no PACTrust statute or regulation. As far as I know, no court with nationwide jurisdiction like the U.S. Supreme Court, Tax Court, or Court of Claims, has ever addressed the PACTrust.
Whats novel is his combining of numerous legal concepts and his arguments. Whether any court will agree with his novel arguments is as yet unknown, and in my opinion, extremely unlikely.
Obviously, this is most likely to be agreed to by people who are not advised by counsel or who are inexperienced. Like most of the too-good-to-be-true guru tricks, it requires you to find and take advantage, not of motivated sellers&Mac226; but of unsophisticated sellers and tenants.
Legal certainty requires statutes and/or court decisions that approve almost identical transactions. Theres no such thing with PACTrusts and probably never will be.
Gatten says he ran into a title company that balked about doing a deal involving his trust because of my Web writeup of it. He said he was forced to pay $3,500 for a legal opinion to prove it was OK. He sarcastically thanks me for forcing him to get that legal opinion.
I would have thought that a layman selling such a complex legal mechanism would have gotten a legal opinion before he started selling it to the public. The Federal Trade Commission and California law both require substantiation of advertising claims. But better late than never.
Gatten says the title company then went ahead and did the deal.
Dose that prove Im wrong? Maybe. But we have to see the legal opinion before I draw that conclusion.
Who wrote it? What are his or her qualifications? And how is it worded? I have seen some expert opinionslegal and otherwisethat contained so many weasel words and clauses that the expert really wasnt saying much at all.
I also need to see what citationsstatutes, court decisions, regulations, etc.it contains and read them. Are they pertinent? Do they cover a PAC Trust or just one little piece of a PAC Trust in a non-PAC Trust transaction. Did they leave out pertinent citations?
The fact is that neither Gatten nor I are attorneys so the two of us debating the matter should be viewed by readers as only a preliminary indication of the legal status of the PAC Trust. Gatten has a powerful conflict of interest in that he makes his living off the PAC Trust so i would be rather devastating for him to be objective about it if it meant no longer being able to sell it. He would claim that I have a conflict-of-interest in that I am his competitor. I suppose, although its certainly less powerful that his incentive.
So if you must do a PAC Trust, get an opinion from your own attorney. Rely neither on Gatten nor me.
Copyright 2000, 2003 by John T. Reed