The Perils of Partition – The Forced Sale of Land (Part 2)
By Robert Moore
In the prior post, we explained partition and the risk it poses to family farmland. Fortunately, there are a few strategies that can be implemented to avoid partition.
One strategy that can prevent partition is the use of a Limited Liability Company (LLC). The concept of using the LLC is to replace the multiple owners of the land with one LLC owning the land. Then, those same owners own the LLC rather than the land. Partition rights only apply to real estate, not to business entities. So, instead of three people owning the land, three people own an LLC that owns the land. Since there are no partition rights with an LLC, no one owner can force the sale of the land.
Consider the following example. Andy, Betty and Charlie are siblings and own a farm together. Each is aware of partition rights and wants to prevent any of the owners, including future owners, from exercising their partition rights. They establish an LLC and transfer the land into ABC Family Farms LLC. The LLC operating agreement states that land can only be sold with the consent of all members.
The three owners of the land have eliminated the threat of partition to the family farmland. The legal owner of the farmland is now the LLC, not the three siblings. Andy, Betty and Charlie are the owners of the LLC but Ohio law does not provide for partition rights of an LLC. Additionally, as added protection, the siblings require unanimous consent before any of the land in the LLC can be sold. By placing the land in the LLC, the three owners have ensured that the only way the farm will leave the family is by joint agreement of the family. A well-designed LLC can make it nearly impossible for land to leave the family without the agreement of the family.
The above example illustrates how an LLC prevents partition by the owners and family members, but LLCs also protect against creditors and lawsuits. Let’s assume Andy has financial problems and creditors have filed and won lawsuits against him. Without the LLC, the creditor could force the sale of the land through foreclosure on Andy’s share. However, Ohio law only allows creditors to attach to an LLC owner’s interest. This means that a creditor is entitled to an owner’s share of the LLC profits but cannot force the sale of the assets owned by the LLC. In this example, Andy’s’s creditors are entitled to receive his share of the profits from the LLC but cannot force the sale of the land. An LLC can prevent an owner’s financial problems or lawsuits from causing the sale of family farmland.
LLCs are often used in estate and succession planning to protect the family farmland. Instead of multiple family members inheriting land (and the risk of partition), mom and dad may establish an LLC for the farmland. Then, the children inherit the LLC without the partition rights. By transferring the land via an LLC, mom and dad do not need to worry that one child or their creditors will force the family farmland to be sold.
Consider the following example. Mom and Dad want their three children to inherit their farmland. They would like their children to own the farmland together as it is too difficult to divide up the land equitably. Mom and Dad are aware of partition rights and want to make sure that no co-owner can force the sale of land against the family’s wishes. Mom and Dad transfer their land to an LLC. Their three children will inherit the LLC with the land. Because each child will own an interest in the LLC, and not an interest in the real estate directly, partition rights are not available. Mom and Dad also established the LLC with the requirement that any transfers of land require unanimous consent of all the members.
This example illustrates how LLCs can be incorporated into estate plans to minimize the risks of partition. By having multiple heirs and beneficiaries inherit the LLC, and not the land itself, the land will not be transferred out of the family due to partition. We often think of using LLCs for liability protection but LLCs may be even more valuable to protect against partition rights.
Another way to protect against partition rights for heirs is to use a trust. With this strategy, the land is owned by a trust rather than the beneficiaries. Since the beneficiaries do not legally own the land, they are not entitled to partition rights. The disadvantage to this strategy is that the trust beneficiaries will not be able to use the assets as collateral nor to build their wealth.
Consider the following example. Mom and Dad want their children to have the benefit of their land upon inheritance but want to be 100% sure that their children do not sell the land before their grandchildren can inherit it. Mom and Dad establish a trust that holds the land for their children’s lives. During the children’s lives, the children receive the rent but do not own the land. Thus, the children cannot take action to sell the land. Upon the death of the children, the grandchildren will receive the land.
While the land is in trust, the children do not own the land. Thus, they do not have partition rights and cannot force the sale of the land. The grandchildren are nearly certain to inherit the land. On the other hand, the land is not available as collateral for a loan and the other benefits of ownership are not available to the children.
As the example shows, trusts are an excellent method to avoid partition. However, trusts also severely restrict the rights of the beneficiaries while the land is held in trust. A careful analysis of the benefits and disadvantages of using a trust to avoid partition must be carefully considered.
In conclusion, before allowing land to be owned jointly, the owners should consider the risks of a forced sale of the land through partition. Partition can be avoided by using LLCs or trusts to hold the land. Be sure to consult an attorney to determine the best course of action to address the perils of partition.