High net worth individuals should be aware of potential estate tax exposure. The tax carries a 40 percent maximum rate that can consume a great deal of what you have been able to earn throughout your life.
There is an unlimited marital deduction that allows you to leave unlimited assets to your spouse tax-free. Asset transfers to people other than your spouse are potentially subject to the estate tax.
In 2014, the first $5.34 million that is passed along can be transferred free of the death tax. This is called the federal estate tax exclusion or credit. Transfers that exceed this amount are taxable.
We also have a federal gift tax to contend with, and it is unified with the estate tax. The exclusion is a unified lifetime exclusion that includes taxable gifts along with the value of your estate.
If you are faced with estate tax exposure, you must implement tax efficiency strategies. Since your home is probably one of your most valuable assets, reducing its taxable value could be part of the plan. This could potentially be done through the creation of a qualified personal residence trust.
To implement this strategy, you convey your home into the qualified personal residence trust. When you create the trust agreement, you decide on a trust term. This is called the retained income period, and you reside in the home as usual during this interim.
You name a beneficiary who will assume ownership of the home after the expiration of the retained income period.
The act of conveying the home into the qualified personal residence trust removes it from your taxable estate. However, because a beneficiary will eventually be assuming ownership of the property, you are giving a taxable gift.
If the gift is taxable, where are the savings? The answer is that the taxable value of the gift will be significantly less than the actual market value of the home.
The Internal Revenue Service will take the retained income period into account when the taxable value of the gift is being calculated. You may be remaining in the home for 10 or 15 years. If you were selling the home under this stipulation, no neutral buyer would pay full fair market value. The interest that you retain is factored into the equation by the IRS.
The taxable value of the gift will be tied to the duration of the retained income period. Longer is better on the one hand, but the home goes back into your taxable estate if you die before the term expires, so you should take this into consideration.
If you are concerned about taxation or any other estate planning matter, send us a message through this page to set up a free consultation: Southampton PA Estate Planning Attorneys.