Passing on Your Home as Part of Your Estate Plan - Rodgers & Associates

Passing on Your Home as Part of Your Estate Plan

For many people, their home is the single largest asset that will be passed on to their heirs. Housing values have come down over the past couple years but even today it is possible for your home value to push your total estate over the annual estate-tax exemption limit ($5.12 million for 2012). The dispo­sition of your home in your estate plan presents some unique issues that retirement accounts and assets such as stocks or bonds do not.

Let’s consider some possible options for dealing with your home that you should discuss with your spouse for possible consid­er­ation in your estate plan.

Keep the home in your estate – If you have owned your home for many years, chances are good that you have a large capital gain in the property. Leaving the home in your name and passing it to your heirs through your will erases the gain. Your heirs will receive the home on a stepped-up basis to its current fair-market value. In other words, their cost becomes today’s market value and will not generate capital gains tax on the appre­ci­ation of your home since the time you bought it.

The other expense to consider is federal estate tax and/or state death taxes. The federal exemption is high this year and may not affect your estate. You will need to check your current state laws to see if they have a death tax and how it applies to your situation. In Pennsyl­vania, the inher­i­tance tax is 4 ½% for property left to lineal decedents. It becomes an easy math calcu­lation to determine if avoiding a 15% capital gain on part of the property’s value is more cost effective than paying 4 ½% on the entire market value.

Gifting the home to an heir — Giving your home to an heir may seem like a sensible solution, however, gifting comes with some pretty strict rules. Signing over the deed or just adding their name as a joint owner consti­tutes a completed gift. If the value of the property is more than $13,000, you will have to dip into your gift tax exemp­tions. A federal gift tax return will need to be filed using IRS Form 709 to declare the gift. In some circum­stances, you and your spouse may have to pay a gift tax. You won’t actually owe any federal gift tax unless the value of the gift exceeds $5.12 million which is the lifetime gift tax exemption for 2012. The deadline to file this return is the same as for regular income taxes.

When you make a gift of your home, your heir will not get the advantage of receiving the home on a stepped-up basis. This means that the capital gains taxes will likely be higher when he or she finally sells the home.

The bigger issue is the number of legal conse­quences involved when you gift the home to your heirs but still intend to live in it. If the heir gets divorced, their spouse could claim an interest in your home as an asset owned during the marriage. They may not be awarded the home since it was a gift from you but the court could take into consid­er­ation this asset in your heir’s name and divide their other property in the spouse’s favor.

You will also need to take into consider what happens to the heir’s ownership if they were to die before you and you are still living in the home? Most spouses leave all their assets to the surviving spouse. You could end up owning the home jointly with an in-law.

In addition you need to consider the issue of creditors. If your heir ends up in bankruptcy you may have to buy out your heir’s interest in the house to avoid having it sold to satisfy creditors. Even if your heir handles their money well they could end up on the wrong end of a lawsuit with a judgment against them.

A qualified personal residence trust (QPRT) – Larger estates (several million dollars) should consider a QPRT for their home. A QPRT involves the transfer of a personal residence to a trust, with the grantor (you) retaining a qualified term interest and the right to live in the home for a specified period. This is a completed gift like option two above and requires filing a gift tax return. The difference is that the home is not valued at fair market value. The IRS takes into consid­er­ation the value of your right to live in your home over the period specified in the trust. This value is deducted from the current fair market value allowing you to claim a signif­icant discount.

One sticking point is that you have to live until the end of the qualified term interest or the value of the residence is included in your estate. However, if you survive to the end of the term, the home passes to benefi­ciaries of the trust. You can then relocate, pay rent, or make other living arrange­ments.

Because a QPRT is a grantor trust, there are special valuation rules for estate and gift tax purposes. You should seek the help of an estate planner to help determine if this is a viable option in your situation.

Rick’s Insights

  • Your home is the single largest asset many people will have in their estate.
  • The home presents some difficult estate planning issues that other assets do not.
  • You should seek counsel with your financial planner to develop an estate planning strategy that works best for you and your heirs.