Most advisors are familiar with the general concept of managing stocks, bonds, mutual funds, and other financial assets in trust. These kinds of assets are efficiently transferred and are easily convertible to cash by the entity receiving them. Less well known are the challenges associated with the transfer, gifting, valuation, and management of real estate or natural resources (oil and gas interests, mining, timber, farm and ranch, etc.), which may be used to fund a trust or other entity.
If properly managed and transferred, these types of assets can provide many benefits not available with more common financial assets. The benefit of real estate or natural resources as an asset can be quite dramatic and realized in two ways: as an income-generating asset that can continue to be used as a powerful ongoing revenue stream, provided the trustee has access to the expertise to handle such matters; and as an asset that can assist in significantly diversifying the portfolio and be used to support the goals and objectives of the trust. It is important that the trustee have a management policy ready and in place to properly deal with these unique assets if they are placed in trust.
With respect to real estate, there are several issues that need to be considered prior to acceptance. Some families may prefer that their real estate not be sold, but rather continued to be used in a specified manner, therefore, consideration needs to be given to how the trustee would provide ongoing management. The trustee also needs to be certain that the asset will not become a burden or an administrative distraction to their administration. It is helpful to have a due diligence process in place to assist prior to acceptance of the asset. Questions include:
- Will the trust have a fee simple title and actual possession?
- What, if any, liens, mortgages, or leases are in place?
- What, if any, environmental liabilities may be present?
- What, if any, zoning or city ordinance violations may exist?
- What is the current physical condition and actual (third party) market value of the asset?
- What are the ongoing expenses such as property insurance, taxes, utilities, maintenance, etc., attributable to owning the real estate?
- Will a beneficiary or other related party be occupying or using the asset?
Similar due diligence inquiry, specific to the interest type, is appropriate for oil and gas, water, gravel, coal, etc. While the type of ownership in oil and gas properties can vary, ownership is generally in non-producing or producing mineral estates, non-participating royalty interests, leaseholds, and working interests.
Ownership in mineral interests and rights to royalties are typically low risk and do not carry much, if any, liability. On the other hand, a working interest includes some risk in regard to the operations of a well. That risk is defined not only as liability for damages, but for the owner’s proportionate cost of operations.
Often, this exposure results in an out-of-hand rejection by trustees of all working interests as a viable asset. There may also be concern about potential state, local or federal tax implications, such as the possibility of incurring Unrelated Business Income Tax in a charitable trust; however, such concerns should not immediately lead to a decision to refuse a working interest, as thoughtful preparation and a well-reasoned asset management policy can provide for creative options to easily accept and accommodate such ownership.
Certainly, converting oil and gas interests into cash before or soon after a transfer eliminates the need for long-term management and affords a one-time cash influx; however, long-term ownership of properly managed real estate, oil and gas, and other unique assets carries the potential to yield extraordinary revenue streams for many years. From a longer term management perspective, transfers of real estate and mineral interests can be a cost-effective way to transition assets for a family, as opposed to incurring the expense associated with a commercial transaction. From the trustee’s point of view, receiving and holding these assets affords a unique opportunity to participate in the powerful cash flows, diversification, and returns associated with holding real estate and minerals.
Most individual and corporate trustees do not have the resources or staff to manage these kinds of assets. But that should not stop them from being open to accepting and holding such assets. Competent outside counsel, valuation specialists, along with real estate and mineral management services are available through organizations such as Bank of Oklahoma to provide the advice and expertise necessary to address the potential risk, and effectively manage these unique assets.