One of the common financial planning concerns that needs to be addressed as a couple or individual ages is that of an estate plan that properly transitions wealth according to the desires of the individual and/or couple. Often times one of the primary assets to be addressed is that of a primary residence. In many cases an estate-planning attorney may recommend a number of strategies that may provide either asset protection, or simply proper titling to avoid probate upon the owner’s passing. Probate is essentially a public hearing in the local surrogate court to administer the estate of a dead person. It is at these hearings that an individual’s will is proven valid, the estate is open to any remaining creditors to resolve their pending claims, and the estate assets are ultimately distributed according to the instructions of the last will and testament. It is also at this proceeding where any individual choosing to contest the will may attempt to do so. If the individual were to die without a will, they are deemed “intestate”, in which case the scenario may become quite a bit more complex. The cost of probate will depend heavily on the size and complexity of the estate, and if the proper documents have been executed. In many counties, the filing fee for estates in excess of $500,000 is as much as $1,000 before any attorney fee is even addressed. Attorney’s fees may be hourly, a flat fee, or in some states it is permissible that they charge a percentage of the individuals estate, which is often a graded percentage tied to the size of the estate ranging from 4% to 0.5%. Avoiding probate is most often beneficial for any estate with a reasonable amount of assets. Aside from the potential costs involved, probate in many counties may take as long as 6-12 months to settle and distribute an estate’s assets, presuming the estate is not being contested, in which case it will likely be dragged on much longer. One of the most potentially problematic kinds of asset is real estate. A real estate holding of any kind does not offer the option of simply naming a beneficiary on the deed of the property with county clerk’s office in order to avoid probate, whereas beneficiaries are commonly named on bank and brokerage accounts. The simple act of naming a beneficiary via a Payable on Death (POD) designation for a bank account, or a Transfer on Death (TOD) on a brokerage account, and standard beneficiary designation on an Individual Retirement Account (IRA) and/or 401k supersedes the probate process, and transfers assets directly to beneficiaries without delay. In the case of real estate, a home, unlike a stock portfolio, comes with maintenance costs. While an estate is waiting to be settled, the executor must still insure that basic expenses are paid. This includes such things as utilities, along with insurance costs, property taxes, possibly homeowner association fees, lawn care and various other expenditures which must be met out of the estate. Additionally, there can always be unforeseen expenses such as the leak in the roof, or the need for a new boiler. Even after the probate process is completed, most real estate holdings still take time to sell should that be the intent of the beneficiaries, which is often the case. There are two very common ways this is avoided. One such way is the use of what is known as a Life Estate. The other is the use of a Living Trust, which may be either Revocable or Irrevocable. The Life Estate is the simpler and less expensive to execute, but comes with many potential pitfalls. The Life Estate is simply the transfer of ownership of real estate to the intended beneficiary, also known as the remainder owner or remainderman, while retaining the right to reside in the residence for the duration of one’s life. The remainder owner takes ownership of the property immediately upon the death of the transferring property owner outside of probate. It will typically provide asset protection for the purposes of Medicaid Planning once a five-year look back period has elapsed. The remainder owner also retains the benefit of a step up in cost basis on the value of the property at the original owner’s date of death, which eliminates the capital gains tax (which can be substantial if the owner resided there for a number of years) should the remainder owner wish to sell the home. One of the largest flaws in the life estate is it essentially locks an owner who has executed a life estate into remaining in the home. Selling a property with imbedded capital gains that has executed a life estate triggers a capital gain. Capital gains applied to a primary residence offer a $250,000 exemption to an individual/ $500,000 per couple. However, this is reduced in the case of a life estate sale. In addition, a portion of that capital gain is then levied upon the remainder owner who will not receive such an exemption. So essentially, what if Mom and Dad execute a life estate on a home they bought 25 years ago for a lot less money as a method to protect an asset and ultimately avoid probate, then later decide they wish to downsize and move to Florida? They will transfer an immediate tax liability to their children as the beneficiaries by forcing them to take on a proportionate amount of the sales proceeds. In order to execute a life estate, one should be absolutely certain they have no intention of ever selling their home during their lifetime. Since this may be difficult to guarantee, quite often the life estate makes the least sense despite its simplicity. The other option is the Living Trust. The trust option is typically more expensive initially to establish. In the case of real estate, the deed must be re-registered to the trust, and the attorney fees will be most often more than that of the life estate. The Revocable living trust provides the benefit of avoiding probate, and permits the individual to serve as their own trustee thereby maintaining control of their home or any asset they choose to place in the trust. However, the revocable trust serves no benefit in terms of asset protection from creditors during one’s lifetime. The Irrevocable trust provides the same avoidance of probate, and does serve as an asset protection/Medicaid planning vehicle for the home or any asset placed into the trust. However, it requires an independent trustee be named. This is often the child/children of the person funding the trust or some other trusted individual. Should the individual choose to place their residence in the trust, and then subsequently wish to relocate, they can simply repurchase the new residence in the same title of the trust. Should the new purchase free up cash from the original sale, the net proceeds can simply be placed into a trust account at the bank or investment account. The irrevocable trust will offer some limitation on income that can be drawn from the cash, as opposed to the revocable trust which will not limit access at all. In the case of a primary residence, this is typically irrelevant as the home is not typically an income producing asset. Both trusts can preserve the capital gains exemption and continue the step up in basis in assets funded into the trust to avoid capital gains taxes being levied on the future beneficiaries. The trust also offers other numerous benefits that can also be stipulated similar to a will, such as placing restrictions on the age in which certain beneficiaries might receive unfettered access upon your passing, or transitioning asset protection to future generations. Under either the life estate or the living trust, in the case of an individual’s residence the retitling of the asset has no impact on the day to day experience of the homeowner. However, the trust option typically provides much more flexibility in terms of limiting one’s potential tax liability and flexibility to relocate. While this general overview may be useful to many investors, the topic of estate planning is a complex one and should be addressed with a qualified attorney specializing in this area. In addition, such decisions should be made in conjunction with an individual’s tax advisor, as well as their investment advisor to ensure they are all properly communicating and working cohesively to address the individual’s goals.
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