Don't Let History Fool You
Massachusetts Realty Trusts and 1031 Exchanges

Massachusetts is the only state in the country that provides for so-called realty trusts or nominee trusts by statute.  For historic reasons, real estate owners in the Commonwealth have held title to real estate in Realty Trusts for a variety of reasons.  Originally, many thought such trusts provided a measure a protection from liabilities.  Furthermore, attorneys suggested to their clients that the Massachusetts Realty Trusts would provide a level of secrecy.  Lastly, some were under the belief that a sale of a beneficial interest in a Massachusetts Realty Trust would escape the real estate transfer tax.  In fact, none of these reasons are valid.

A Massachusetts Realty Trust is typically evidenced by a trust agreement that is recorded in the land evidence records.  The trust agreement provides the basic elements of a trust, including appointing a trustee, providing for beneficiaries, and identifying a corpus or assets of the trust.  The typical Massachusetts Realty Trust provides that the beneficiaries are the owners and are to receive all distributions from the trust.  The interesting feature of these trusts is that the beneficiaries are not named in the body of the trust agreement.  Rather, they are identified on a separate schedule of beneficiaries, which separate schedule is not recorded.  Bare legal title to the real estate is held in the name of the trust, but the beneficiaries claim all other ownership interests.  Banks and other lenders in the Commonwealth are familiar with these types of ownership arrangements.

As set forth above, the historic reasons for using the realty trusts no longer exist, if they ever did.  First, because the realty trust is typically self-settled (meaning that the person who established the trust did so for their own benefit), and because the realty trust is revocable at anytime, the trust provides no measure of protection to the beneficiaries from the claims of creditors.  Second, most realty trusts name at least one of the beneficiaries of the trust as a trustee.  As a result, very little secrecy exists.  Additionally, if all of the beneficiaries are also trustees, or if the sole beneficiary is also the sole trustee, then the doctrine of merger collapses the trust, resulting in no trust.  Even if an independent trustee is appointed, a competent lawyer will be able to remove all veils of secrecy.  Third, and most important for purposes of Section 1031, a beneficial interest in a Massachusetts Realty Trust represents an interest in real property under Massachusetts law.  Therefore, since the Massachusetts realty transfer tax applies to all transfers of real property for consideration, the sale of a beneficial interest in a Massachusetts realty trust is a transfer of an interest in real property and the transfer tax must be paid.  This tax must be paid at the time of transfer even though the sale of a beneficial interest in a Massachusetts realty trust does not require any document to be recorded.

From a tax perspective, a properly drafted Massachusetts realty trust should be treated as a disregarded entity, or, at worst, as a grantor trust.  In either event, the trust is effectively ignored for income and estate tax purposes.  A properly drafted realty trust should not file federal income tax returns, regardless of the number of beneficiaries.  The income and expenses should be reported on the Schedule E of the beneficiaries' individual tax returns.  However, confusion sets in when the trust files partnership or trust tax returns, even when such returns are improper.

All of this becomes highly relevant in planning for a section 1031 exchange because partnership interests and interests in trusts are precluded from 1031 exchanges.  Since the beneficial interest in a properly drafted realty trust represents an interest in real property under local law (i.e. the laws of the Commonwealth), a beneficial interest will be eligible for 1031 exchange treatment.  Thus, for example, the sole beneficiary of a Massachusetts realty trust can sell his or her beneficial interest and purchase a direct interest in real property in a 1031 exchange.

Caution should be taken when undergoing exchanges and other transactions involving Massachusetts realty trusts.  Other avenues are available to achieve some of the goals of realty trusts, such as single-member limited liability companies.