When it comes to setting up a revocable trust, most people are primarily concerned with avoiding the time and expense associated with the probate process. To avoid probate, it is crucial that legal title to any real property is transferred to the trustee of the trust. In discussing the importance of funding the trust with real property, many clients want to know whether or not the transfer to the trust will trigger an acceleration of the debt on the property under a “due-on-sale” clause. Although the question is fairly common, the answer is not as straightforward as you might expect.
Transfers of a Personal Residence
Under federal law, due-on-sale provisions are regulated by the Garn-St. Germain Depository Institutions Act of 1982 (Garn Act). The Garn Act, as interpreted by the Code of Federal Regulations, prevents a lender from enforcing a due-on-sale clause when a home is transferred to a revocable trust in which the borrower is a beneficiary and the home is occupied (or will be occupied) by the borrower. As far as California law is concerned, a due-on-sale clause cannot be enforced if the property transferred into the revocable trust is “residential property” and the borrower is a beneficiary of the trust. Here, “residential property” is defined as “any real property which contains at least one but not more than four housing units.” Therefore, under both federal and California law, transferring your personal residence into your revocable living trust will not trigger a due-on-sale clause.
Transfers of Commercial or Investment Property
The ability of a lender to enforce a due-on-sale clause for transfers to a revocable trust becomes more unclear when the property transferred is not the borrower/beneficiary’s personal residence. As already mentioned, California law does not contain the same requirements as the Garn Act—that the borrower must remain the occupant of the property in order to prevent enforcement of the due-on-sale clause. On the other hand, the Garn Act expressly states that it was intended to override state law. In general, when federal and state laws conflict, the federal law controls. Thus, the Garn Act appears to allow for the enforcement of a due-on-sale clause when the borrower/beneficiary does not occupy the property. However, this issue has not yet been fully tested in the courts.
In light of this uncertainty and the potentially high stakes involved, if the property transferred to the trust is not occupied by the borrower/beneficiary, the best course seems to be to get the lender’s written permission before transferring the property. A lender typically charges a modest fee for this consideration, but there is no guarantee—especially if the interest rate on the loan is significantly lower than the current market rate. At any rate, while funding your revocable trust with real property is critical to avoiding probate and making the most of a revocable trust, transfers of commercial and non-owner-occupied residential property must be handled with care.