When you die, do you want to create chaos and negativity as you pass away? If so, then make sure to do almost zero estate planning! No matter your level of wealth, if you don’t do any planning of your estate, you could easily leave your children or relatives with very few assets, and the assets you do leave may incur massive expenses for those who receive them. Additionally, you may create serious arguments among your heirs. For example, if your children do not get along and end up as co-owners of your house, they must still agree on how, if, and when to sell your property, and this can create bitter, relationship-ending disputes. If intense, posthumous disputes are the legacy you’d like to leave behind, then a severe lack of estate planning is a great way to achieve your goals.
If you’re already exhausted thinking about estate planning, relax; this is work that you should mostly leave to professionals. Find a good estate planner, and have them advise you on the best way to arrange your estate based on your individual situation and goals. One helpful resource is the non-profit National Association of Estate Planners and Councils. Also, if you have a retirement account through your work, you can often get some help from a financial adviser.
Though you should always discuss estate planning with a professional, there are a few larger concepts that are helpful to at least partially understand so you can be prepared to get the most out of discussions with your estate planner. One important consideration is that there is no single best way to transfer your estate. The best way for you to transfer your assets depends on the size of your estate, the types of assets you own, and the state in which you live. For example, if you live in Florida, there is no state estate tax. However, even in Florida, you still would owe federal estate taxes, which range from 18% to 40%. This is a significant tax, but it only applies to estates worth more than $13.61 million (this figure changes frequently). This means that only about 8 in 10,000 estates pay federal estate tax at all. If you live in Iowa, however, estates of more than $25,000 owe estate taxes (with certain exceptions). Thus, the state where you live, as well as estate size, has a massive effect on tax burden.
As we’ve discussed using Florida as an example, if you live in one of the 33 states with no estate tax, then you’ll only owe estate taxes if you have an estate worth more than $13.61 million (remember that this number changes often). If you have an estate of this size, you probably stopped reading this article within the first paragraph, because you likely have already been over these issues with a professional, and if you haven’t, stop everything you’re doing and call one right now. For the rest of us in those 33 states, it’s not so much federal estate taxes to be concerned about, it’s things like capital gains taxes and state taxes.
If a piece of real property is a significant part of your estate, the first thing you should do is determine your heirs’ level of interest in this property. If you are passing your house to an heir who cannot afford property taxes and can’t pay for maintenance, they may have to sell the property shortly after receiving it. Selling property in a short time frame means the price may have to be extremely low. If you’re passing on a vacation home to your three children, consider whether they really want to use this vacation home, or if owning this home together will cause financial disputes and other arguments. It’s nice to imagine that they will all use the old family vacation home together in perfect harmony, but let’s be honest, this may be a disaster.
After you’ve had a good, realistic talk with yourself and your heirs about who will best take care of and appreciate your real estate, it may be a good idea to put this real estate into a trust so that the property will immediately pass to your heirs on your death and avoid probate. Putting property into a trust is not an extremely difficult process, though it does require professional help. The basic idea is rather simple–you will no longer own your property as an individual person, but your property will be owned by a trust called something like “(Your Name) Revocable Trust.” Your heirs will be named as the beneficiaries of this trust, so they will essentially replace you in the trust once you pass away. Neither you nor your beneficiaries will own the property, but will be the beneficiaries of a trust that owns the property.
One essential consideration regarding real property and trusts is capital gains tax. When an heir inherits property, they get a potentially massive shield from capital gains tax. This massive tax shield involves a concept called “stepped up basis.” If you bought a property for $100,000 decades ago and sold it for $800,000, you would owe capital gains taxes on $700,000 worth of gain. Your original basis in the property is $100,000, and you are not taxed on your original investment (aka your “basis”), which is why you’d be taxed on $700,000 of gain and not on the full sale price of $800,000. However, if you spent $100,000 on a property decades ago that is now worth $800,000, did not ever sell the property, and your heir inherited it, your heir’s basis in the property would be “stepped up” to its current market value of $800,000. Thus, your heir would pay zero capital gains taxes if they sold the property for $800,000. A simpler way of saying this is that capital gains tax liability is essentially erased when property is inherited. Unfortunately, someone has to die to activate this amazing tax break, but I guess everything has a price.
Capital gains tax is also a significant consideration when creating a trust. For example, if you put your real estate into a revocable trust, your heirs will likely get a stepped up basis in your property when they inherit it, so they will likely avoid capital gains taxes. However, if you put your property into an irrevocable trust, your heirs will not avoid capital gains tax. This is because an irrevocable trust does not change in any fundamental way once you die, so death of the grantor (you) is not particularly relevant to an irrevocable trust. However, a revocable trust automatically becomes an irrevocable trust upon your death, and this change in the nature of the trust creates a stepped up basis for your beneficiaries, according to the IRS.
Don’t get me started on Intentionally Defective Grantor Trusts (IDGTs), which function partially as irrevocable trusts, and partly as revocable in the eyes of the IRS. I’ll stop talking about these right now, other than to say that they create a hybrid of tax advantages that can help save your estate money. My point in referencing this somewhat boutique type of trust is to point out that there are a surprising number of options available to suit your specific situation, options that can dramatically change the amount of money you have now, and that your heirs have in the future. A good estate planner will be able to listen to your wishes, and then outline the most cost-saving options to suit your goals. Though I’m not an attorney, I am absolutely certain that assuming your assets will simply sort themselves out after you die is the worst of all the options you’re considering.
I do not expect you to be an expert in estate planning after reading this–I’m not that good of a writer! But I hope that, if you’ve made it this far in this article (and in life) that you have a general, ballpark idea of some of the complex issues to bring up with your estate planner. I also hope you have a new appreciation for how important estate planning is for everyone, no matter how big or small your estate.
I’d also like to backtrack on something I said earlier–you can in fact plan your estate with a skilled professional, and still create absolute chaos when you pass away. If you let your planner know that you’d like to create unbelievable expenses and set up bitter disputes among your heirs, some skillful estate planning could absolutely create a wake of chaos upon your death. The choice is yours!
https://www.covenantwealthadvisors.com/post/how-to-avoid-estate-taxes-with-a-trust
https://finance.yahoo.com/news/pay-taxes-trust-inheritance-130026222.html
https://www.fidelity.com/learning-center/personal-finance/estate-planning
https://smartasset.com/estate-planning/how-to-avoid-estate-taxes-with-trusts
https://www.nerdwallet.com/article/investing/estate-planning/putting-house-in-trust
https://www.fidelity.com/viewpoints/wealth-management/insights/intentionally-defective-grantor-trusts
https://www.dhclaw.com/library/when-are-beneficiaries-in-florida-liable-for-inheritance-tax.cfm
