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Trustee's Certification Legal Document

How an Irrevocable Trust Can Be an Accredited Investor

Here's another way that some people who otherwise wouldn't be able to invest in certain real estate deals can get access.

[Updated: Feb 04, 2021] Aug 26, 2019 by Dan Caplinger
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Real estate is one of the most popular asset classes, with millions of people owning their own property. In order to invest more broadly in real estate, though, you'll want to look into the many different types of investment vehicles available. For many of them, you'll need to be qualified as an accredited investor, and that often takes financial resources that most people don't have.

However, there's another way that some fortunate individuals can benefit from the advantages of investing in real estate. The securities laws allow irrevocable trusts to be treated as accredited investors if they meet certain requirements. That can help you or even your entire family gain exposure to investment-quality real estate.

The gateway to serious real estate investing

Anyone can purchase their own real estate outright, but having accredited investor status is a requirement for many other types of real estate investments. Whenever you pool your investment dollars with a group of similar investors, the securities laws come into play, asking certain requirements of whoever is collecting capital and investing it. In some cases, the shares of stock in the entities that these investment managers create are registered with the U.S. Securities and Exchange Commission to make them available to the general public.

However, in most cases, real estate vehicles aren’t registered with the SEC, and the manager has to qualify for an exemption to the securities laws in order to solicit investments. Restricting access to accredited investors is a popular exemption. As a result, regardless of whether you're looking at a fund that holds a specific commercial property, or a larger vehicle with an entire portfolio of diversified real estate holdings, you'll often need to be an accredited investor in order to participate and invest in those offerings.

The problem with becoming an accredited investor is that it's difficult. Under Rule 501 of the U.S. Securities and Exchange Commission's Regulation D, which defines the term accredited investor, individuals either have to have a net worth of $1 million excluding the value of their primary residence, or have earned at least $200,000 per year in each of the past two years and expect to do so again in the current year. Married couples are allowed to aggregate their assets for the $1 million test, but they must have a joint income of at least $300,000 annually to meet the income test instead. One alternative is to become a director, general partner, or executive officer of the investment vehicle, but that's often unavailable to ordinary investors.

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What's an irrevocable trust?

An irrevocable trust is an estate planning vehicle that people use to transfer assets to others. Under the terms of an irrevocable trust, the person creating the trust contributes property to the trust and also establishes the terms under which the trust beneficiaries can obtain distributions of income or principal. What makes a trust irrevocable is that once you create the trust by executing the trust document, there's no changing your mind -- you're locked into what you've agreed to do under its terms.

In the irrevocable trust, you'll name a trustee to manage the assets of the trust. You can act as the trustee yourself, but more often a third party will serve that role. As you'll see below, the decisions that go into creating the trust have major implications for whether the trust can be treated as an accredited investor.

How irrevocable trusts can get accredited investor treatment

However, there's another way that investors can indirectly get the benefit of real estate investing as an accredited investor even if they don't individually meet the financial requirements. Irrevocable trusts have their own rules for qualifying for accredited investor status, which you can see below:

  • An irrevocable trust that was not formed specifically for the purpose of investing in the investment vehicle in question, has more than $5 million in assets, and has a trustee who qualifies as a "sophisticated person" for securities law purposes, can be treated as an accredited investor.
  • If the trustee or co-trustee of the irrevocable trust is a bank, insurance company, registered investment company, business development company, or small business investment company, then the trust can be an accredited investor regardless of its size.
  • If each of the people creating the trust is an accredited investor in his or her own individual right, then the trust will also carry accredited investor status.

These rules are pretty straightforward, with the exception of who qualifies as a sophisticated person. The securities laws have a fairly vague definition in this situation, requiring someone "who has such knowledge and experience in financial and business matters that he or she is capable of evaluating the merits and risks of a prospective investment." One key factor that will likely go into that determination is the amount of past investment experience the trustee has, especially in the type of investment at issue. What's clear, though, is that it's possible to be a sophisticated person without meeting the accredited investor standard in your own individual capacity.

Addressing some challenges of irrevocable trusts as accredited investors

One problem that can come up with irrevocable trusts is that because they require some additional work on behalf of the investment manager overseeing the process of raising investment capital, not all real estate investments will accept irrevocable trusts. That's especially true because of the fact that the SEC puts the burden of verifying investors' claims of accredited investor status on the investment manager rather than retaining it itself at the regulatory oversight level.

However, there are still some ways to make investment managers more comfortable with irrevocable trusts. The clearest is to bring on a bank, an insurance company, or another qualifying institution as co-trustee. If the irrevocable trust has a financial institution as trustee or a co-trustee, then that can put the manager more at ease, because there's no question that the trust meets the standard under the rules without further due diligence.

Also, even if the trust has an individual trustee, anything that supports that trustee's standing as a sophisticated person can be helpful. Documenting investment experience is a great way to raise comfort levels among investment managers, by showing both the length of time that the trustee has been an active investor and the amount of money involved.

The benefits of irrevocable trusts

Because the securities laws make it clear that setting up an irrevocable trust solely to get around the provisions of the accredited investor rules governing individuals generally won't work as a strategy without an institutional trustee, you won't often see investors using it solely to gain accredited investor treatment. However, if estate planning issues make it prudent to have an irrevocable trust anyway, then using it as a real estate investing vehicle can be a great way to give the beneficiaries of the trust the advantages that investing in real estate can bring.

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