Legal Tip of the Week – 1/24/17!

Asset Protection comes in many flavors but when it comes to protecting your primary residence, it may be difficult to have your cake and eat it too.  A lot of people think that putting a home into an irrevocable trust is the easiest solution.  However, not many people think through the mechanics of setting up such a trust and its impact on taxes.  There are a few different taxes to consider, but for the most part, an estate attorney is concerned with gift taxes, estate taxes (or death taxes), income taxes and/or capital gains.

The reason why irrevocable trusts are popular as an asset protection tool is because the Grantor (i.e the person setting up the trust) can gift an asset into this type of trust for the benefit of other individuals.[1]  This means that once the asset has left the dominion & control of the Grantor and is placed in the trust, the Grantor stops receiving any benefits from the trust.  The asset is then removed from the estate of the Grantor for estate tax purposes and is therefore out of the reach of creditors.  Depending on how the trust is structured, the Grantor may still be liable for the income taxes, but in most cases that ends up being the better tax consequence.

However, in the case of putting a primary residence into an irrevocable trust, if the Grantor (and his/her spouse) wants to continue to live in the home, they would either need to pay fair market value in rent to the trust, or set up a Qualified Personal Residence Trust (“QPRT”).  A QPRT is an estate tax avoidance strategy (rather than a creditor protection strategy), and once the Grantor-homeowner outlives the term of the QPRT, he or she will then have to pay rent to the trust from that point onwards.  With these and other strategies that a homeowner may employ, there may be loss of other benefits related to homeownership.  For ex. Once the home is out of the estate, the homeowner loses the valuable capital gains exclusion upon sale during lifetime; he or she may not be allowed to take property tax deductions/exemptions; and the beneficiaries will lose the stepped-up basis afforded at the death of the homeowner.

So when it comes to protecting your home, make sure to consult with an estate planning attorney who can counsel you on how to effectively accomplish your goals and objectives.  You may not be able to have your cake and eat it too, but we can definitely help you enjoy a few flavors.

[1] In most states (NJ/NY/PA included), self-settled trusts established to benefit the Grantor do not offer creditor protection.