This is another in a series of blogs on the basics of estate planning. Last week, I discussed how the transfer of real estate into a trust could trigger issues regarding Homeowner’s Insurance and Title Insurance. There are many other issues to consider. This week, I’ll look at tax and asset protection considerations.

Taxes

• Capital Gains Tax: Transferring a residence to a grantor trust (like a revocable trust) does not interfere with the grantor’s $250,000 (or $500,000 for joint returns) capital gains exclusion, provided the property otherwise qualifies.

• Deductions: After the property is transferred to a grantor trust, the grantor can continue to claim deductions for mortgage interest and property taxes paid by the trust.

• Property Tax: Some states offer a homestead exemption that serves to reduce property taxes for homeowners. This exemption can be very valuable. If your state offers this exemption, check to be sure that transferring a residence to a trust does not interfere with the exemption. Also, think about how property tax reassessment works in your state. Some jurisdictions don’t have periodic reassessment of property taxes—only a reassessment upon the transfer of the property. If the property has appreciated in value, make sure that transfer to the trust will not trigger property tax reassessment.

•  Estate Tax: When the property is in a revocable trust, it is included in the estate of the grantor for estate tax purposes. As a result, there is a step-up in basis (in most cases) to the date of death value due to Section 1014 of the Code. If the property is in an irrevocable trust, this same result would occur, as long as the property is included in the estate of the grantor. This may be accomplished by giving the grantor a general or limited power of appointment, a right to income, or other powers described in Sections 2036 through 2038.

Asset Protection

• Tenancy by the Entirety. In some states, property held in “tenancy by the entirety” is given an extra level of protection from creditors. A few states allow property to maintain its “tenancy by the entirety” status in a trust. But, in most states, transferring such property to a trust destroys the tenancy by the entirety protection. Prior to transferring tenancy by the entirety property to a trust, consider:

• Your state’s rules for allowing a trust to hold property in tenancy by the entirety, and

• Whether any loss of asset protection is worth the advantages offered by funding the property into the trust.

• Bankruptcy. Debtors’ homes are given preferential treatment under bankruptcy law. This is called the “debtor’s homestead exemption.” This exemption varies from state to state. For example, a Florida resident can protect his or her home – no matter the value – from creditors in bankruptcy. In other states the exemption may be limited to $100,000 or less. In some states, however, transferring a home to a trust means losing the homestead exemption in bankruptcy. If bankruptcy is a possibility, it is imperative to know your state’s bankruptcy law before deciding whether to fund the home into a trust.The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) significantly altered the availability of homestead exemptions. Under BAPCPA, the exemption doesn’t apply to a greater extent if they have moved within 1215 days of bankruptcy. The amount of equity they had in their residence 1215 days prior is still protected. If they had no prior residence, then they would be limited to $125,000, adjusted for inflation since 2005 (currently over $160,000).Example: John owns a primary residence worth $150,000. There is no mortgage. Three years before filing bankruptcy, he buys a new primary residence worth $500,000. There is no mortgage. John can only take advantage of the bankruptcy exemption allowable, up to the equity in his home as of 1215 days prior to the bankruptcy filing, or $150,000.

Amazingly, there are still more issues to look at! Next week, we’ll look at a number of additional concerns you’ll want to be aware of before you transfer real estate to a trust.

In other upcoming blogs, I’ll discuss more on the basics of estate planning.

Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com