In this blog post we will examine the way that New York trust law allows you to transfer your home to a beneficiary at an estate and gift tax discount. However, to understand the value of these trusts, you must have some background information about federal transfer taxes.
Taxes on Asset Transfers
People who have been able to accumulate a significant store of wealth should be aware of the federal estate tax parameters. The death tax can play havoc with your financial legacy, because it carries a very significant rate. At the time of this writing in 2016, the maximum rate of the federal estate tax stands at 40 percent.
There is a federal estate tax credit or exclusion. This is the amount that can be transferred to people other than your spouse tax-free.
You do not have to use any of your exclusion to transfer assets to your spouse in a tax-free manner, because there is an unlimited marital deduction. This allows you to transfer any amount of property to your spouse free of taxation.
After a legislative measure was passed in 2010, a $5 million exclusion was established for 2011. A subsequent measure called the American Taxpayer Relief Act of 2012 was passed at the very end of that year. As you may recall, that measure saved us from plummeting over the highly ballyhooed “fiscal cliff.” There have been ongoing adjustments to account for inflation each year since then.
After a series of inflation adjustments, the exact amount of the estate tax exclusion is $5.45 million in 2016, and you should not be surprised if the figure rises when 2017 rolls around.
In addition to the federal estate tax, there is also a gift tax on the federal level. These two taxes are unified under the tax code. The $5.45 million exclusion that we have in 2016 is a unified lifetime gift and estate tax exclusion. It applies to lifetime gifts that you give along with the value of your estate.
To clarify by way of example, if you gave $3.45 million in tax-free gifts, there would be just $2 million left to apply to your estate after you pass away.
Qualified Personal Residence Trusts
Now that we have explained some things about federal transfer taxes, we can look at qualified personal residence trusts.
If you are exposed to the federal estate tax, you must take steps to gain estate tax efficiency. Since your home is probably one of your most valuable assets, if you could reduce its taxable value, you would be making headway.
To implement this strategy, you fund the trust with your home, and you name a beneficiary. The beneficiary would assume ownership of the home after the term of the trust expires. The trust term is called the retained income period.
You do not have to worry about an immediate disruption of your living environment. As the grantor of the trust, you decide on the duration of the retained income period. During this interim, you can continue to live in the home as usual, rent-free.
When you fund the trust with the home, you are removing the value of the home from your estate for tax purposes. However, the beneficiary is eventually going to assume ownership of the home, so you are giving a taxable gift to the beneficiary.
This is the bad news; the good news is that the value of the taxable gift will be far less than the actual fair market value of the home.
The taxable value of the gift is reduced because of the retained income period. Let’s say that you set a retained income period of 15 years. Suppose you told a neutral buyer that you wanted to sell the home, but the buyer could not assume ownership or 15 years.
No one would pay full market value under those circumstances. The IRS uses this rationale when the taxable value of the gift is being determined.
After the expiration of the retained income period, the beneficiary assumes ownership of the home, and the transfer tax consequences are minimized.
New York State Estate Tax
We have been working with the federal estate tax to this point, but we should point out the fact that we also have a a state-level estate tax here in the state of New York. New York trust law allows for various different types of trusts be used to gain estate tax efficiency, including qualified personal residence trusts.
Learn More About New York Trust Law
To learn more about New York trust law and other relevant estate planning topics, explore our electronic library of special reports. These reports are free, and you can click this link to view all the titles: Free Estate Planning Information.
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