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Major issues that can “make or break” your estate plan
Over the last couple issues of “Estate Planning & Probate News” we’ve discussed some of the key intricacies of estate planning for residential real estate and commercial real estate. In this article, we’ll address some “make or break” issues that can dramatically affect your estate as it related to real property.
Proper titling
As an estate is settled, it is common for beneficiaries to assume that a property is held by the trust, when in fact it may be held by other parties. This may have been the intent of the trustor or it might have been an oversight. As such, a key task of your estate planning attorney is to establish the correct title for all properties held by your trust.
Creating a will can designate intended plans for real estate but it is very important to take the next step and ensure that all assets are properly titled. The titling (or ownership structure) will impact how your assets are distributed, whether or not they need to go through probate, and estate taxes required. For example, if you own a home jointly with someone, the titling determines the disposition, e.g., your share could be distributed to your surviving spouse, to your estate, or to a third party.
Financing and Liens
If your home has a mortgage on it, you’ll need to consider some options in estate planning. Most mortgages have a "due on sale" clause that may be triggered at death. If so, the inheritor would need to qualify for a mortgage on their own, or the home would need to be sold, or other liquid assets in the estate would need to be used to pay off the debt. If there is a mortgage balance that goes unpaid upon your death, the lender then has the right to foreclose, taking ownership of the property to recoup their losses on the debt.
This can be an unforeseen and sad situation when a beneficiary can’t qualify for a mortgage and has to sell the family home (for example, a grandchild who inherited the home but is still in college). However, there are some possible solutions to this dilemma, such as co-ownership with the heir, a revocable trust, or a qualified personal residence trust (QPRT). Talk with your attorney about the limitations and pros/cons of each option.
Heirs might be surprised to find liens on inherited property (e.g., HOA dues, property taxes, lawsuits, etc.). A lien is a legal right or claim against a property by a creditor. Liens are commonly placed against property so that creditors can collect what is owed to them. A lien expires 10 years from the date of recording or filing; note that sometimes liens are mistakenly not lifted even after the debt has been satisfied.
Taxation
Real estate owners often spend a lifetime accumulating prime real estate assets. If such assets need to be sold to pay estate taxes, those efforts are lost. With proper estate planning, however, those assets can be maintained for future generations.
The current federal estate and gift tax exemption ($12.06 million in 2022 per individual, or twice that per couple) is scheduled to end on the last day of 2025. Unless Congress makes it permanent, the exemption amount will drop back down to the prior law's $5 million cap, which, when adjusted for inflation, is expected to be about $6.2 million. The 2025 expiration date is coming up quickly, so it is important to consider your options if you have a real estate portfolio over $6.2 million. You should also consider the exemption amount and related rules for your state of residency.
Entire books are written on the topic of tax law as it applies to estate planning, but we’ll focus on just a few opportunities, some of which are fairly sophisticated and are designed for estates above the exemption amount (talk with your attorney about your specific circumstances):
- Consider transferring property when the value is low to allow future appreciation outside of the estate and to lower estate tax liability. Note: Before making transfers, it is important to consider the income tax characteristics of the assets. Transfers of negative basis property or property encumbered by debt in excess of basis should generally be avoided.
- Set up different ownership structures for new real estate ventures. Family members or trusts can be established for the initial owners of any entity acquiring a new property.
- For partnerships, considering use of the Code Section 754 election, in which a partnership may elect to adjust the basis of partnership property when property is distributed or when a partnership interest is transferred.
- Establish a Spousal Lifetime Access Trust (SLAT), which is an irrevocable trust where one spouse makes a gift into a trust to benefit the other spouse (and potentially other family members) while removing the assets from their combined estates. Since a SLAT is funded with a gift made during the spouse's lifetime, any post-gift appreciation will take place in the trust and be excluded from the estate of both spouses for federal estate taxation purposes.
- Initiate steps to freeze the value of the estate, such as through grantor-retained annuity trusts (“GRATs”), installment sales, and partnership freezes.
- Keep in mind Section 6166 Estate Tax Deferral, which permits deferral of estate taxes attributable to business interests over 14 years at substantially reduced interest rates. Such deferral may allow sufficient time to dispose of illiquid assets or otherwise raise cash instead of a fire sale.
- For large estates, consider a Dynasty Trust. The biggest advantage of a dynasty trust is that it can save your descendants a significant amount of money in estate taxes. The assets you put in the trust (plus any increase in their value over the years) are subject to the federal gift/estate tax just once, when you transfer them to the trust.
Risk Assessment
Any real estate investor knows that real estate investments come with inherent risks. However, are your heirs aware of these risks and equipped to deal with them? Consider providing formal and informal education to heirs in order to equip them to continue your dynasty (whether professional real estate management is used or not). These risks include: variances in market value over time and differing economic conditions; access to financing; depreciation of assets and related tax planning; negative cash flow/financial losses; liability/legal ramifications; vacancy and evictions; maintenance costs; and liquidity concerns as related to conversion to cash, estate taxes, property taxes and other operating costs.
Experts in Estate Planning for Real Estate
We’ve attempted to make this series of articles on estate planning for real estate as easy to understand as possible. However, the reality is that the nature of this asset category makes it complex, particularly considering all the variables and risk factors. The good news is that Mortensen & Reinheimer, PC is ready to help simplify the process for you and we’ll handle the complexity of it all – while maximizing these opportunities and achieving your goals. Please contact us at (714) 384-6053 to make an appointment, or use our online contact form. Our website is http://www.ocestateplanning.net.
About the author:
Tamsen R. Reinheimer, Attorney, is a Certified Specialist in Estate Planning, Trust & Probate Law (The State Bar of California Board of Legal Specialization). She has significant experience in all aspects of estate planning, trust administration, and probate. Contact Tamsen at tamsen@ocestateplanning.net