Today, we’re talking about the unpleasant topic of death and estate planning – and what it means for homeowners and real estate investors.
That means, we’ll outline some estate planning basics of making sure:
— Your assets are inherited by the people you want to inherit them
— Your heirs don’t pay more taxes than they have to
— The transition is as clean and simple as possible.
This particular conversation needs the disclaimer. We’re talking about some basic concepts in estate planning here, but this isn’t legal or financial advice. If you hear something that catches your attention, talk over your situation with a local attorney.
The first part of estate planning is making sure your assets get passed to the right people. To accomplish that, there are six general ways to go about it.
6 General Ways To Approach Estate Planning
- Using a Will: Unless the deed contradicts your will, you can always name your heirs is a will. Done correctly, you can impose a creative range of conditions, alternates, and restrictions on the inheritance. This method creates the most work up front and potentially more work to administer, but it’s the most flexible.
- By a Joint Tenancy: Many deeds will create a “joint tenancy” right on them. This creates automatic inheritance by co-owners with the “last man standing” to gain full ownership.
- By Life Estate: Lesser used, you could create a life estate on a deed. This is when you keep ownership during your lifetime but designate the heir in the deed itself.
- By Revocable Trust: Like a will, this requires some up-front work but allows for greater flexibility in designating heirs. Unlike a will, the trust will operate automatically.
- By Irrevocable Trust: This is the same thing as a revocable trust, just that it’s irrevocable. Whether it’s worth taking on an irrevocable trust depends a lot on your specific financial situation.
- By Business Entity: You can also pass along interest in your LLC, partnership, or corporation. For this to work well, make sure the business documents, your will, and any other estate plan are not contradictory.
- (Default): If you don’t have a will and your deed doesn’t contain a joint tenancy or life estate, than your heirs will be determined by the court.
Tax planning for real estate investors is a tension between capital gains tax planning and estate tax planning. Generally, if you own an asset until you die, it’s part of your estate and could be subject to the estate tax, but it gets the benefit of a stepped up basis. If you give away ownership during your lifetime, it’s usually not part of your estate (avoiding the estate tax) but doesn’t get the benefit of a stepped up basis.
With the current federal estate tax threshold over $11M, the avoidance of estate tax has become important to less people.
For the 6 types of estate plans, 5 of them are considered part of the estate. The irrevocable trust does not get the benefit of the stepped up basis and therefore should be less popular to real estate investors. However, there are some concerns, such as long-term care planning, that may make the irrevocable option more advantageous.
Finally, we talk about the operational complexity for each method:
Operational Complexity of Each Estate Planning Method
- Wills: are overseen by the probate court. This is not fatal, but this could cause delays in resale, mortgaging, or other transactions important to investors
- Joint Tenancy: automatic, sometimes a death certificate and occasionally an affidavit of no divorce would be required to prove title. Life Estate: same as joint tenancy
- Revocable Trust: The trustee should be competent and empowered to act. Transactions involving a trust require some additional forms and affidavits, but real estate attorneys can and regularly handle them.
- Irrevocable Trust: operationally the same as revocable trust
- Business entity: what exactly is required would require a review of both the estate documents and the business documents. If written with efficiency in mind, then this could be fairly straightforward.
- With no estate planning: This requires the highest level of court supervision to prove the rightful heirs and correct distribution of assets.
Key Estate Planning for Real Estate Takeaways
- There are several, easy ways to craft your estate.
- For real estate investors, the stepped up basis is the key benefit for tax planning. However, this has a tension with the estate tax. It’s also a moving target subject to changes in laws and tax rates.
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