We have all watched our home values go up over recent years, and it is exciting to see your fortunes rise. Here in Manhattan, real estate has always been expensive, and the median annual cost for a home right now is just over $650,000 according to Zillow.com.
This is the good news, but there is some bad news that can enter the picture from an estate planning perspective.
The federal estate tax can become a problem if you are in possession of valuable real estate and other assets. It carries a 40 percent rate, and it can be levied on the portion of an estate that exceeds $11.7 million.
This figure is called the credit or exclusion, and it is at a record high level as a result of a provision contained within the Tax Cuts and Jobs Act. This measure is going to expire on January 1, 2026, and the exclusion will go down to $5.49 million at that time.
If you are married, you are entitled to utilize the unlimited marital deduction if you are married to an American citizen. There is no limit to the amount of property that can be transferred between spouses tax-free.
Of course, the surviving spouse would be in possession of a taxable estate. However, when the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 was enacted, the exclusion became portable.
In an estate planning context, the term “portability” is used to describe the ability of the surviving spouse to use their deceased spouse’s exclusion. Using the figure that is in place this year, your surviving spouse would have a total exclusion of $23.4 million.
Here in New York, we have a state-level estate tax, and the exclusion is $5.93 million this year, so your estate could get a double dose of taxation.
The tax situation would be no big deal if you could give gifts while you are still alive, but that loophole was closed for good when the gift tax was installed in 1932.
It is unified with the estate tax, so large lifetime gifts that you give while you are living will eat into the exclusion that will be left to apply to your estate.
There is no gift tax per se on the state level, but you cannot give deathbed gifts to avoid the estate tax. We have a three-year claw-back period in New York, so significant gifts that you give within three years of your death are considered to be part of your estate for tax purposes.
Qualified Personal Residence Trust
You can transfer your home in a tax efficient manner if you convey it into a qualified personal residence trust. When you are drawing up the trust declaration, you name a trustee to act as the administrator, and your children (or anyone else you choose) would be the beneficiaries.
Your living situation does not change at all because you dictate term during which you will still live in the home as usual rent-free. This is called the retained income period, but you have to be conservative because the strategy does not work if you die during this period.
The home is no longer part of your estate for tax purposes after you convey it into the trust, but you are going to be giving a taxable gift to the beneficiary. However, the value of the gift for tax purposes will be far less than its actual value.
No one would pay fair market value for a home that they would not be able to sell, rent, or occupy for years. The Internal Revenue Service weighs this factor when they determine the taxable value of the home, so it will be a fraction of the real value.
We Are Here to Help!
We can help you implement an estate tax efficiency strategy if it is necessary, and of course, we assist clients that do not have estate tax concerns. When you choose our firm, you will receive personalized attention, and your estate plan will be tailor-made to suit your needs.
You can schedule a consultation at our Manhattan, NY estate planning office if you call us at 212-973-0100, and you can use our contact form if you would rather send us a message.