Estate Planning For Real Estate
Proper estate planning ensures your real estate is managed and transferred according to your wishes while protecting your assets and simplifying inheritance for your heirs. Some tools for estate planning include wills, which designate who will inherit your property; trusts, which provide control over distributions and potential tax benefits; ownership structures, such as joint tenancy, tenancy in common, or LLCs. Transfer on death deeds and other non-probate vehicles for naming beneficiaries can be used too. An effective estate plan will use the tools most appropriate to your unique circumstances and will help minimize legal headaches during what will be an exceptionally difficult time for your loved ones. In this article, we discuss how some of these tools can be used for transferring real estate assets.
Different Ways of Passing Property
One of the primary distinctions in how property is transferred upon death is “probate” vs “non-probate.” In a probate transfer, the property is part of the probate estate and transferred by a court according to will, or intestacy. In a non-probate transfer, the property is transferred by private parties outside of probate.
Probate Transfers
Probate is a legal process for the distribution of a deceased person’s property according to a will, or local intestacy law, based on where the person resided at time of their death. Note, where real estate is involved, the applicable law for the real estate will be determined by where the real estate is located, not where the deceased resided at the time of their passing.
Things to Consider
- Probate is the default method of transfer. For small estates under $100,000 in Washington, probate can be relatively simple.
- In Washington, jointly held property transfers to the other owners when one owner dies, regardless of what a will may say.
- Property does not need to pass through probate for a step-up in tax basis.
Non-probate transfers
Non-probate transfers provide a faster alternative to court-supervised probate. They typically take precedence over probate transfers—Where an asset passes outside of probate, it is not in the probate estate when probate is settled.
Things to Consider
- Most non-probate transfers don’t happen automatically; they must be set up.
- Distribution via non-probate methods is generally quicker and offers more certain results.
- Some non-probate transfers can be designed to use gift exemptions and to pursue other tax advantages.
Tax Planning for Estates
Passing real estate through inheritance and gifting it during your lifetime can have two very different tax implications:
Basis Step-Up
When property is transferred because of death, the property receives a step-up in basis–Rather than the basis being the purchase price as if the recipient acquired it with cash, or the residual basis of the previous owner as if receiving by gift, the basis is its fair market value at the time it is received. This applies to real estate. And it is especially significant when substantial capital gains have been deferred, for example, by 1031 exchanges.
Gifting Limits
Gifting during life is another way to make transfers outside of probate, and to reduce any estate or inheritance tax burdens at the state level. But there are some limits on gifting both federally, and in some states, excluding Washington. And, in some cases, lifetime gift exemptions can also be counted against estate tax exemptions.
Estate and Inheritance Taxes
Estate taxes are based on the value of a probate estate. There is a federal estate tax, and many states, including Washington, have one too. The tax depends on the estate’s size and assets.
Inheritance taxes, on the other hand, are based on what a person receives from an estate. The amount owed depends on the recipient’s tax situation and the inheritance received. There are no federal or Washington state inheritance taxes.
Trusts
Trusts are legal entities that hold assets for beneficiaries. Trusts can allow people to decide how their property will be managed and distributed—The trust will be administered by a “trustee,” according to the trustor’s wishes, for the benefit of named beneficiaries. Trusts of any type can be used as a means of non-probate transfer. Generally, though, only irrevocable trusts for beneficiaries other than the trustor, or grantor, will qualify for tax advantages.