Cummings & Lockwood Estate Planning FAQs

If you own a residence at the time of your death, it will be included in your estate for estate tax purposes.  As with other assets, your estate will get a “step-up” in cost basis as of the date of death so that there would be no gain on sale if it was sold at the date of death valuation price.  For many people who purchased a home long ago, it be might be advantageous to hold onto the house until they die in order to wipe out the potential capital gains. 

Your executor has to open a probate in any state in which you own real estate at the time of your death.  In order to avoid this, many people transfer their homes into the name of their revocable trust.  This will not avoid estate taxes but it will avoid having to go through an ancillary probate.  However, it is important before making any transfer to confirm it would not adversely affect any possible homestead exemptions in states such as Florida. 

Another approach to avoid probate would be to place the house in the name of an LLC so that the membership interest is what is owned instead of the real estate itself.  This may also avoid estate taxes in some states, but this area is still evolving.  Also, the manager and members of any LLC will need to determine if the LLC is subject to the FinCen reporting requirements of the Corporate Transparency Act.

There are several approaches that could be utilized when making gifts of real estate but, as with any gift, the recipient will receive a carryover cost basis in real estate.  Accordingly, it is important to evaluate whether and how much capital gains might be passed on to the recipient and whether the tax effects will outweigh any potential estate tax benefits.  The approaches most commonly used are:

• QPRT (see separate white paper topic)
• Sale to Grantor Trust (see separate white paper topic)
• LLC
• Outright gift or in trust (see below)

The threshold question with any of this planning is do the children want the home at all?  Different beneficiaries may have different economic situations or live in different places across the country or world and may not make the same use of the property.  It is important to have open conversations and discussions to ensure that over time the property (and expectations) can be managed properly.  There also should be some discussion of how much money is needed to sustain the property and whether it can be rented to unrelated people.

A trust can be used in which a trustee controls the real estate, but that may place the trustee in the position of having to balance different beneficiaries’ interests and use of the property. 

A limited liability company is often a good way for managing a second or vacation home.  The family or trusts for their benefit will own the property as members of the LLC and the LLC Operating Agreement will set out the rules for managing the property.  The managers will manage the property, and the Operating Agreement will set out how managers will be succeeded and elected.  Also, the manager and members may have to comply with ______ reporting requirements under the Corporate Transparency Act.

An exit plan for members should be thoroughly discussed: will there be provisions for buying out a member and, if so, how will that be done?  Over time or immediately?  At what price?  Will there be any transfer restrictions on a member’s death, divorce or creditor problems?  How will the property be managed as generations continue?  How will usage be scheduled?  How will expenses be managed?  Through an endowment or contributions?  If there is a dispute how will it be resolved?

There are no “correct” ways to answer these questions or even best practices approaches other than to have open and honest discussions regarding the property.  Property held at the “siblings” level can often be managed fairly well, but once the property descends to the “cousins” level and people’s personal and economic situations begin to diverge, and the number of people with interests begins to multiply, it is difficult to balance interests unless the property is endowed with substantial funds.

The benefits of making a gift in trust is if the donor is married, he or she can retain indirect use of the real estate, because the spouse, as beneficiary of the trust, would be entitled to use the property rent-free.  Normally, if a donor makes a gift of a residence, the only way he or she can still use the property is if he or she pays fair market rent.  Otherwise, the IRS would likely argue that the donor retained use of the property and seek to include the property in the donor’s estate under the retained life estate provisions of Internal Revenue Code section 2036.

However, if the spouse dies or they become divorced and the grantor desires to continue to use the property, or, if the donor does not have a spouse, he or she would need to rent from the trust.  This can actually be a positive planning technique, since if the trust is structured as a “grantor trust,” the payment of rent will not be considered income for the trust and the payment of rent becomes, in essence, an additional gift tax free gift to the trust.

Making a gift of the real estate in trust versus outright is also a way to protect and preserve the real estate for the intended beneficiaries.  If a gift is made outright to a beneficiary and the beneficiary dies, gets divorced or has creditor problems, the real estate would be disposed of in accordance with the beneficiary’s estate plan or may be subject to divorce or bankruptcy proceedings.  Retaining the real estate in a properly drafted creditor protection trust can keep the property protected from those claims.

The grantor can also set out in the trust agreement exactly how the real estate will be managed.  Use of a trust will effectively restrict the transfer of the real estate and keep its use within a class of beneficiaries.  The trustee controls how and when the property is used.  An important part of putting the real estate in trust is to provide for how the real estate expenses will be made.  Will it be expected that the beneficiaries contribute or pay rent?  What if some of the beneficiaries use the property and some don’t?  It may make sense to endow the trust with a sum of money to cover capital expenses and repairs.  Even so, it can be difficult for a trustee to manage the divergent interest of the beneficiaries.