Whether putting your house in a trust is a good idea depends a good deal on your personal circumstances. For example, one of the primary benefits of putting a house in a trust is to avoid probate upon your death. Not only can you avoid a very public probate process, you can also save time on transferring assets as you wished to your heirs and also avoid paying the expense of the probate process (~3% in fees).
On the other hand, putting your house in a trust may not make sense because you don’t plan on dying anytime soon, and you don’t want to deal with the set-up cost, maintenance cost and complexity of a trust while you’re still alive.
Here are some factors to consider when deciding whether to put your house in a trust:
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Probate avoidance: If you want to avoid probate, which is the court-supervised process of distributing assets after someone dies, a trust may be a good option. By placing your house in a trust, it can be distributed to your beneficiaries without going through probate.
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Privacy: If you value privacy, a trust may be a good option. Probate proceedings are public, meaning anyone can see your will and the distribution of your assets. By using a trust, you can keep your affairs private.
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Control: If you want more control over the distribution of your assets, a trust may be a good option. With a trust, you can set conditions for the distribution of your assets and even name a trustee to manage your assets if you become incapacitated.
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Cost: Creating a trust can be expensive, so it’s important to consider the cost and weigh it against the potential benefits. Additionally, transferring your house into a trust may trigger certain tax implications.
Benefits of putting house in a trust
Putting your house in a simple revocable trust can offer several benefits, including probate avoidance, privacy, and control over the distribution of assets. There are also significant tax benefits from placing assets other types of trusts like irrevocable trusts which we’ll discuss in the next section.
One of the main advantages of placing your house in a trust is probate avoidance. Probate is a legal process that occurs after someone dies to distribute their assets according to their will or state law. Probate can be time-consuming, expensive, and public, which can cause stress and inconvenience for your loved ones. By placing your house in a trust, it can be distributed to your beneficiaries without going through probate. This can save time, money, and reduce the stress and uncertainty associated with probate proceedings.
Another benefit of placing your house in a trust is privacy. Probate proceedings are public, meaning that anyone can see your will and the distribution of your assets. By using a trust, you can keep your affairs private. This can be especially important if you value your privacy or have complex family situations that you want to keep confidential.
A trust can also provide you with more control over the distribution of your assets.
With a trust, you can set conditions for the distribution of your assets and even name a trustee to manage your assets if you become incapacitated.
This can give you peace of mind knowing that your assets will be distributed according to your wishes.
Finally, placing your house in a trust can provide your beneficiaries with protection against creditors and lawsuits. When your assets are held in a trust, they are separate from your personal assets, which can provide an additional layer of protection for your beneficiaries.
This last point is quite important to understand, as placing your house in certain types of trusts (i.e. irrevocable trust) means it’s legally separate from you, and as a result isn’t something your creditors can go after.
Pro Tip: You can cover the cost of probate or the costs of setting up a trust by getting a commission rebate when you purchase your home with a Hauseit Buyer Closing Credit. Your Hauseit buyer’s broker will give you 2/3 of the commission he or she earns on the transaction which you can apply against your closing costs, or receive as a check post-closing. It’s free for you to work with a buyer’s broker, no exclusivity required.
A revocable trust, also known as a living trust, is a trust that the grantor can change or revoke at any time during their lifetime. With a revocable trust, the grantor maintains control over the assets in the trust, including the house. The grantor can transfer ownership of the house to the trust, and as long as they are alive and competent, they can make changes to the trust agreement, including removing the house from the trust.
On the other hand, an irrevocable trust is a trust that cannot be changed or revoked by the grantor once it has been created and funded. Once a house is transferred to an irrevocable trust, the grantor gives up ownership and control of the house to the trust and its designated trustee. An irrevocable trust can provide benefits such as creditor protection, tax benefits, and asset protection, but once the trust is created, the grantor cannot make any changes to it.
In summary, if you put your house in a revocable trust, you can maintain control over the house and make changes to the trust agreement if your circumstances change.
In contrast, if you put your house in an irrevocable trust, you give up control over the house but can benefit from the trust’s potential asset protection, creditor protection, and tax benefits.
Potential tax benefits of an irrevocable trust
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Estate Tax Reduction: One of the primary reasons people use irrevocable trusts is to reduce their estate tax liability. When property is transferred to an irrevocable trust, it is no longer considered part of the grantor’s taxable estate, which means it may not be subject to estate taxes when the grantor dies.
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Gift Tax Reduction: Similarly, transferring property to an irrevocable trust can be a way to reduce gift taxes. When the grantor transfers property to the trust, it is considered a gift, but the value of the gift is reduced by any interest the grantor retains in the property. If structured correctly, the grantor can reduce the value of the gift and avoid or reduce gift taxes.
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Income Tax Reduction: An irrevocable trust can also offer potential income tax benefits. If the trust is structured as a grantor trust, the grantor is responsible for paying income taxes on the trust’s income, which means the income is not taxed at the potentially higher trust tax rates. Additionally, the grantor may be able to deduct certain expenses related to the trust, such as trustee fees or legal fees.
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Capital Gains Tax Reduction: When assets are transferred to an irrevocable trust, the basis of the assets is generally adjusted to the fair market value at the time of the transfer. This can potentially reduce capital gains taxes if the assets are sold in the future.
Pro Tip: Should you put a house in a trust or a LLC? Read our article on buying property through a LLC to learn the benefits and the difference between the structures.
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Technically, putting your house or other assets into an irrevocable trust shields them from estate tax because they are no longer part of your estate. However, there is no free lunch as gifts made to an irrevocable trust are subject to the same lifetime gift tax exemption as other gifts.
For 2023, the lifetime gift tax exemption amount is $12.06 million per person. This means that an individual can give up to $12.06 million in gifts during their lifetime without incurring any federal gift tax.
However, when making a gift to an irrevocable trust, there are a few strategies that can be used to potentially reduce or eliminate the gift tax liability:
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Gift-splitting: If you are married, you and your spouse can each make a gift of up to the annual exclusion amount ($16,000 in 2023) to the trust, effectively doubling the amount of the gift without incurring gift taxes.
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Discounting: Assets that are gifted to an irrevocable trust can be discounted for gift tax purposes, meaning that their value may be reduced to reflect the fact that they cannot be easily sold or transferred. This can help to reduce the overall value of the gift for gift tax purposes.
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Grantor Retained Annuity Trust (GRAT): A GRAT is a type of irrevocable trust that allows the grantor to transfer assets to the trust and receive an annuity payment from the trust for a set number of years. At the end of the term, any remaining assets in the trust pass to the beneficiaries without incurring gift taxes. This strategy can be useful for transferring assets that are expected to appreciate in value.
In summary, no there is not a glaring loophole in tax law that allows you to completely avoid the estate tax by putting your house in an irrevocable trust.
How does a Grantor Retained Annuity Trust work?
A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust that allows you to transfer assets to the trust while retaining an annuity interest in the trust for a set term. The annuity payments are made back to you, as the grantor, on a regular basis, typically annually. At the end of the term, any remaining assets in the trust pass to the trust beneficiaries, usually your heirs, without incurring gift taxes.
Here’s how a GRAT works in more detail:
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You establish a GRAT and transfer assets into the trust. The assets can be cash, stocks, or other types of property. The value of the assets is based on the fair market value at the time of the transfer.
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You choose the term of the GRAT, which is typically between 2 and 10 years. During this term, you retain the right to receive an annuity payment from the trust each year, which is calculated based on the value of the assets in the trust and an IRS-prescribed interest rate known as the “7520 rate“.
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At the end of the term, any assets that remain in the trust pass to the beneficiaries you have designated, typically your heirs. The beneficiaries receive these assets free of gift tax.
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If the assets in the trust appreciate at a rate that exceeds the 7520 rate, there will be excess assets remaining in the trust at the end of the term, which can pass to the beneficiaries without incurring additional gift tax. This means that the GRAT can be an effective strategy for transferring assets that are expected to appreciate in value.
There are potential risks associated with a GRAT, including the possibility that the assets in the trust may not appreciate as quickly as anticipated, which could reduce or eliminate any tax savings.
Pro Tip: If you’re this concerned about saving money on taxes, one of the easiest moves you can make is to eliminate your state and local tax liability by moving to a tax-free state like Florida. New Yorkers can check out how much they can save with our updated NYC Income Tax Calculator, and everyone can learn more about the pros and cons of living in Miami before making a move.
So why do most people not bother with putting their house or other assets into a trust? Because of complexity and cost. As a result, putting your house or other assets in a trust may only make sense if the value is great enough to warrant the additional costs involved.
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Complexity: Establishing and managing a trust can be complex, and it will require the assistance of an attorney and/or financial advisor. There may be ongoing administrative tasks, such as filing tax returns, that can be time-consuming and require professional assistance. This can add additional, ongoing costs and complexity to the process of transferring a house into a trust.
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Cost: Establishing and maintaining a trust can be expensive. There may be legal fees and other costs associated with setting up the trust, as well as ongoing costs for administration and management. The costs of establishing and managing a trust can be higher than other estate planning strategies, such as a will or joint tenancy. Just think for a moment about how much extra your accountant is going to charge you every year for the additional filings!
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Loss of control: When you transfer a house into a trust, you give up some degree of control over the property. The trustee of the trust will have legal control over the property, and you may need their approval to sell or make changes to the property. This loss of control can be a disadvantage if you want to make changes to the property or if you have concerns about the management of the trust.
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Potential tax consequences: While transferring a house into a trust can provide tax benefits, there are also potential tax consequences to consider. For example, if you transfer a house into an irrevocable trust, you may lose the ability to take advantage of certain tax deductions or exemptions that you would otherwise be entitled to as the owner of the property.
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Difficulty in financing: If you transfer a house into a trust, it may be more difficult to obtain financing for the property. Lenders may be hesitant to loan money to a trust, as it may be more difficult to collect on the loan if the trust defaults. This can make it difficult to obtain a mortgage or other loans that may be necessary to finance the purchase or renovation of the property.
Establishing a trust can involve substantial, ongoing administrative tasks and costs which will vary depending on the type of trust and the assets held in the trust.
Here are some examples of ongoing costs and filings that may be required to maintain a trust:
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Tax returns: Depending on the type of trust, you may be required to file annual income tax returns for the trust. This can be a complex and time-consuming process, and it may require the assistance of an accountant or tax professional.
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Accounting and record-keeping: You may need to keep detailed records of all transactions involving the trust, including income, expenses, and distributions. This can be a time-consuming process, and it may require the assistance of a bookkeeper or other professional.
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Legal fees: Depending on the complexity of the trust and the assets held in the trust, you may need to consult with an attorney on an ongoing basis to ensure that the trust is being managed properly. This can result in additional legal fees and expenses.
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Trustee fees: If you appoint a professional trustee to manage the trust, you will need to pay their fees and expenses. The fees for a professional trustee can vary depending on the size and complexity of the trust.
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Reporting requirements: Depending on the type of trust, you may be required to provide periodic reports to the beneficiaries of the trust. This can include information on the trust’s assets, income, expenses, and distributions.
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Amendment and termination costs: If you need to make changes to the trust, such as adding or removing assets or changing the beneficiaries, you may need to pay additional legal and administrative fees. If you decide to terminate the trust, there may also be costs associated with winding down the trust and distributing the assets to the beneficiaries.
Remember that putting a house or any other asset into a trust is a complex financial decision that should be made in consultation with your personal financial advisor, accountant and/or legal team. And lastly, don’t forget to consult your family (or at least your spouse)!
Pro Tip: If you’re a real estate investor, you may wish to consider the trade-offs of a trust vs any potential tax benefits you might lose. For example, if a rental property is owned by an irrevocable trust, the trust would be treated as a separate taxpayer for federal tax purposes, and it would file its own tax return. However, whether or not the trust qualifies as a real estate professional would depend on the specific facts and circumstances of the situation.
