Transferring Real Estate to Heirs, Part 5

One of the more frequent estate planning conversations we hear centers upon the transfer of real estate from a person to his-or-her heirs (usually children). This is the fifth and final post in a series of posts reviewing some general information on doing that. As we are typically talking about “the house”, this post will refer to “your house”, but everything here applies to any real estate.

In the previous posts we have considered what happens to property that you own with others (“concurrent interests” if you like fancy-shmancy legalisms), and we talked about leaving property to others through your will (called a “devise”), a trust, what happens if you have no will or trust, and ‘traditional’ life estates.

This brings us to a consideration of the Enhanced Life Estate. To explain this we are going to contrast it with the ‘traditional’ life estate, so reading the previous post might be helpful.

Enhanced Life Estate Deed. With an Enhanced Life Estate Deed, you could transfer the remainder to your child or to a trust that would permit greater control of the property after your death. The Enhanced Life Estate Deed is something of an innovation, a specially designed instrument that is only available in certain states, including North Carolina. It is similar to a traditional Life Estate Deed in that it is a deed that conveys property to another (called a remainderman) at death (of the life tenant). The difference is that while with the traditional life estate (WARNING: LEGALSPEAK COMING) the remainderman’s interest is vested when the deed is signed, with the ELE deed it is NOT vested until you die. In English: with the ELE your child doesn’t have anything until you die. You retain the right to change your mind. That’s right. Without your child’s consent, you can take the property back and give it to someone else. In addition, you have the right to sell or mortgage the property and keep all of the proceeds without your child’s consent. And there are no present tax implications (the IRS calls it an “incomplete gift”).

Just as with a traditional life estate, the remainderman can be one person, multiple people (in equal or unequal shares), or a trust.
• There is no probate (with respect to the property) when you die.
• The transfer will be clear of many of the creditor problems you may develop in the future; but if you are having trouble with creditors when you make the transfer it may not protect the house from them.
• This type of transfer will not disqualify you for Medicaid (because it is an incomplete gift).
• You do not have to file a gift tax return (because it is an incomplete gift).
• The Remainderman receives a step-up in basis.
• Mortgage company approval is not required.
• Condo association approval should not be required.
• As of TODAY the property would not be available for estate recovery if you die on Medicaid. (We cannot guarantee that the law won’t change in the future. See below)

• DMA hates these things. They have not managed to get rid of them in NC yet, but the day is probably coming. This means that if time is on your side (you have the 60 months) a trust is probably a preferable alternative.
• While your child does not have a vested interest, if your child has any income tax liens or judgment liens, they may have to be paid off before you could sell the property. There are differences of opinion on this point. Until there are court decisions resolving these issues, we must assume that the liens might have to be cleared. Many attorneys (myself included) take the position that if you can sell your property without the signature of your child, then why should you have to pay off the child’s lien in order to sell your property. If you believe that this could be an issue, you should consider the use of an irrevocable trust to serve as remainderman.
• If your child dies before you, the remainder interest goes to her or his heirs. If you are still living and have capacity to sign another deed, this can be remedied. But there is the risk that you would not be. If you anticipate that this could be an issue (e.g., “family land”), you could establish an irrevocable trust to serve as remainderman.

In conclusion, the Enhanced Life Estate Deed is an incredible tool for avoiding probate with minimal downside when compared to the non-trust alternatives, but like most such things should not be done without careful consideration of how it fits with your particular situation and goals.
QPRT. Finally, as an unexpected bonus—at no additional charge, a quick word about QPRTs. While not common in NC, they can be used here. And we have clients that come from areas where they had had past dealings with these critters. We may do a more in-depth look at these in a later post, but now a brief word.

QPRT is an acronym for Qualified Personal Residence Trust. While this could be used for Medicaid planning, its original and still most common use is for estate tax planning. If structured properly, the QPRT will freeze the value of your residence at the time you create the trust and therefore result in significant estate tax savings (because the future appreciation of the home is removed from your taxable estate). This is helpful assuming, of course, that estate tax liability is an issue and that the home will continue to appreciate. It is used much more in the Northeast, where not only are house values often considerably higher than here, but many states also impose their own estate tax in addition to the federal tax, and so the impact of the value of the house is more of an issue than here.

The method: you establish a properly-drafted QPRT and transfer your house to the trust. The Trust gives you an unqualified right to possession of the house for a set period of time (the trust term). Then comes the rub: at the end of the term you must relinquish the house (to the kids). It may be worth it, but you want to proceed cautiously after thorough analysis. The decision requires balancing the potential estate tax savings, based in part on current interest rates and the effect of the projected appreciation of the property on your overall estate, against both the consequences of relinquishing ownership to the next generation and the costs involved. The accounting may not be simple. Careful consideration should be given to both tax and non-tax consequences.

As always, this conversation is of a general nature and is NOT A SUBSTITUTE for coming in and discussing YOUR PARTICULAR SITUATION with us. We will offer you coffee, and we rarely bite. You might see a cat. Also, this conversation is based on North Carolina law at the time it was written, and assumes that both you and the real estate in question are in North Carolina.

2016 Estate Tax and the Presidential Candidates

One of the frequent topics around these parts involves the estate tax. There is nothing new here: taxes on the transfers of wealth date back to ancient Egypt. Pyramids don’t come cheap. And Caesar Augustus taxed transfers on death, though he made an exception for transfers between certain close family members.

These taxes can have odd effects. Similar taxes in the late Middle Ages were one of the forces that resulted in the Church owning a large percentage of the land in Europe by the time of the Reformation. Later in England, when a handful of families controlled most of the land, these taxes had the effect of breaking up these large estates and make what we would recognize as ownership of real estate possible for many more people (and ushering in modernism). In the United States, the similar taxes were among the tools used to break up the monopolies held by people like Carnegie, Rockefeller, and Morgan.

And—oh, yes, it was also a revenue source in all of the above cases… One thing all governments throughout time and space have had in common: a thirst for other-people’s wealth.

The estate tax as we have it dates to 1916. It was substantially reshaped during the 1970s, when exemptions for gift and estate taxes were combined in a 1976 bill that resulted in the unified gift and estate tax system we have today. (Prior to 1976 there were two separate tax-schemes, one gift and one estate, which resulted in numerous loop-holes.) The result of the 1976 bill is a genuine wealth transfer tax: the federal government limits the amount of wealth that you can transfer without being taxed (called the “unified credit”), subject to certain exceptions. It does not matter whether you transfer the wealth during your lifetime (a gift) or when you die (through your estate). Furthermore, if you sell property to a family member for substantially less than fair market value the government will call the difference a gift, and count that against your credit.

So the credit amount becomes a key to proper estate planning (though not the only one). Today, the credit amount (which, again, is the amount you can pass to others without paying the tax) is $5.45M (2016). The two presidential campaigns have different views on this. The Trump campaign wants to eliminate the tax (on the federal level). The Clinton campaign wants to drop the credit to $3.5M, and raise the tax rate from 40% to 45%. Of course neither of them can accomplish this in isolation, tax bills originate in the House of Representatives. But it is an indication of their thinking. And it is an indication of something else—you recall the old saying “Two things are certain: death and taxes.” It was not that long ago that many well-intentioned advisors were telling people that they really need not worry about the estate tax—“look how high the exemption is!”. Well, today. But maybe not tomorrow. And in terms of effect it is really not very high, but that is a different post. The point is that you cannot simply disregard the estate tax. Even if repealed, it could come back with one vote. It has before, it will again. And failure to plan for that reality creates real problems: The tax is a tax on wealth, but it is paid out of income. Depending upon the nature of one’s estate and assets, this can create an insurmountable burden for those you leave behind. Which is why planning is so important…

So the point of this post is not that you should vote for Clinton so that American wealth isn’t locked up in a few families. The point is not that you should vote for Trump because estate taxes have bad effects. The point is not that you shouldn’t vote for either one of them because they are both full of corn flakes. The point is that you should plan for what will happen when you pass away, and then review the plan periodically based upon changes in your life circumstances, the life circumstances of your prospective heirs, and changes in the law. And you should not count on any relevant factor remaining static; things change and estate plans need to be fluid. The only thing that doesn’t change is that things change. So formulate your goals, and then let’s work together to help your family accomplish them.