Older Americans have a total of more than $17 trillion of equity in their houses. Transferring that residential real estate to your heirs upon your death often is the most complex part of family estate planning because of all the legal, tax and financial implications.
The traditional solution has been to use your will to leave instructions about who gets your house when you die—but that can come with significant drawbacks (see below). There are other ways to do it including revocable and irrevocable trusts and transfer-on-death (TOD) deeds that may be cheaper, faster and more private and give you better control over what happens to the house while you are alive as well as after you are gone.
To help you determine the best way to leave property upon death, Bottom Line Personal spoke to estate-planning attorney Jennifer Gumbel, JD. Here are the four methods she recommends…the pros and cons of each…and who should consider them.
Leave the House In Your Will
How it works: A will provides for the distribution of any assets and property you own at the time of your death. You name an executor to manage the administration of the estate. Upon your death, your will enters probate, a legal process in which your state validates the will and oversees that your wishes are carried out after debts and taxes are paid.
Pros…
- Relatively low-cost. Your estate attorney will charge a fee to create your will, which will guide distribution of our assets including your house.
- Establishes legal clarity. If you don’t assign a beneficiary to inherit your house, a probate court will decide who inherits it and what portion of the value of the house he/she is entitled to using your state’s “intestacy” laws. These laws may not align with your wishes.
- Step-up in cost basis. If you have owned your house for decades, its value has probably soared and the profits you make selling it could leave you on the hook for hundreds of thousands of dollars in capital-gains taxes. On the other hand, if you leave your house in your will and your heirs sell it after your death, the IRS allows them a break—the house is revalued to its fair market value on your date of death, which can reduce or eliminate the capital-gains taxes your heirs owe.
Cons…
- Probate can be costly and time-consuming. This is government bureaucracy after all. The probate process typically takes several months—but it can drag on much longer if there are disputes among beneficiaries or challenges to the will’s validity. Because of the bureaucracy of the probate process, there are significant costs all while assets are frozen. Ultimately the expenses of probate are charged to the estate, but loved ones may need to come up with the funds to begin the proceedings and hope for reimbursement later.
- Wills and probate filings are public documents, meaning that anyone can view the will’s contents once filed with the court, as well as the assets you own and who inherits them.
- Inability to specify rules/conditions for the home’s use or sale. A will lets you decide who gets your house, but typically courts do not let you restrict your heirs’ ability to sell the house or use it the way they want.
When this is best
This can be a better option when a trust is not feasible. This assumes that you don’t need stipulations about the long-term management of the house.
Use a Transfer-on-Death (TOD) Deed
How it works: Many states have begun to offer this no-fuss way to transfer ownership of your house directly to an heir or heirs. This is similar to how you list a beneficiary for your 401(k) or IRA. A TOD deed specifically addresses real estate you own and can be used in conjunction with a will for your other assets. You designate one or more beneficiaries to inherit your house and record it with your county land records office. During your lifetime, you have full ownership and control of the home, and you can amend or revoke your TOD deed at any time. Important: A TOD deed overrides any conflicting inheritance wishes about your house in your will.
Pros…
- Streamlines property transfer. TOD deeds avoid the court probate process. Upon your death, your beneficiary can claim ownership of the property right away by submitting an affidavit and a death certificate. Note: Like a will, a TOD deed does become public record. A TOD also can be used in conjunction with a trust to move real estate to a trust upon death.
- Cost. Real estate documents are technical documents that work best when prepared by an attorney or real estate professional. In many cases, these cost only a few hundred dollars to prepare and record with the county.
- Step-up in cost basis for your beneficiaries when they eventually sell the house.
Cons…
- Not recognized in all states. Eligibility depends on the location of the property. More than 30 states now offer TOD deeds, but some larger states such as Florida, Michigan and Texas do not.
- Lack of flexibility. Like a will, you generally cannot impose specific conditions or rules about what happens to the house after you die.
- No protection from creditors. If your estate has unpaid debts, creditors can put a lien on your property seeking repayment. Your heir(s) would inherit the property with the existing lien. Unresolved claims can make it difficult to sell or refinance a house.
- Multiple beneficiaries. There is no legal authority among the beneficiaries to sell or act. Unlike a probate or trust, all beneficiaries may be required to act together to take action. In many states, spouses of the beneficiaries also will need to sign off on a transaction.
When this is best
You want to transfer your house automatically upon your death.
Set Up a Revocable Living Trust
How it works: A trust is a legal structure into which you transfer the title to your house during your lifetime and create rules for who gets the home after your death and how it will be managed. The trust takes effect immediately, but you are allowed to serve as your own trustee, make changes to or revoke the trust anytime you want, and maintain complete control over the house in your lifetime. When you die, a successor trustee you’ve appointed takes over. After your death, the trust becomes “irrevocable,” meaning that its terms must be followed and typically cannot be changed.
Pros…
- Useful if you are still alive but become incapacitated. Your successor trustee can legally manage your trust by the terms you lay out if you are unable to do so yourself.
- Avoids probate. This often is the main reason for having a trust. Court approval and oversight is not required to pass the house to your heirs. Privacy is maintained because trusts are not public documents.
- You retain control. You can leave very detailed conditions for how the trust is managed after your death. Example: You can put restrictions on when a beneficiary can sell the house or at what age he/she can receive ownership of it. Important: You also can direct who will make decisions about the home after you’re gone in light of your instructions, avoiding the need for cooperation among multiple beneficiaries and their spouses.
- Reduces challenges to your wishes. Anyone can file an objection to a will and contest it in court, but it’s much harder and more expensive to challenge a trust.
- Step-up in cost basis for your beneficiaries.
Cons…
- Higher costs. Due to the complexity of trusts and the variation in state-level rules, you need an estate attorney to set up a trust and should expect to spend several thousand dollars at least.
- Lack of protection against creditors. If you are in debt or lose a lawsuit, creditors may try to seize your house or put a lien on it.
When this is best
A trust is the most comprehensive and flexible way to transfer a home to your heirs. It is especially useful if you have a complex family situation such as multiple and/or contentious beneficiaries, minor children and/or very specific preferences about how the home is to be managed after your death.
Establish an Irrevocable Trust
How it works: You create a trust while you are alive that cannot be modified or revoked. You relinquish both control and ownership of the house, although you can stipulate that you are allowed to live in it for the rest of your life or if it is sold. You get the similar advantages as having a revocable living trust (including avoiding probate and public exposure), but there are additional tax and legal advantages.
Pros…
- Asset protection. In some states, you may be able to protect the home from creditors and, in some cases, remove the home for qualification purposes for medical assistance eligibility.
- Potential estate-planning benefits. You may be able to remove the house from your taxable estate if your rights are restricted.
Cons…
- Even more costly than revocable trusts to create due to their complexity, specialized nature and the additional legal expertise required for asset protection and tax-planning features.
- No step-up in cost basis. Because the house is technically no longer part of your estate at the time of your death, your heirs receive a gift that may be a taxable gift. They also will have your original cost basis—usually the price you initially paid for the house—if they choose to sell it.
When this is best
When homeowners have very complex and specific needs. Example: If you are planning for long-term care by going on Medicaid, transferring a house to an irrevocable trust can preserve it for your heirs. Otherwise, Medicaid is allowed to recover the costs of your care by putting a lien on the house after your death. Note: To protect your home, you need to establish the irrevocable trust at least five years before you apply for Medicaid.
