The federal estate tax looms large if you are a person of significant financial means. At the present time, the amount of the federal estate tax exclusion is $5.34 million. This is the amount that could be transferred before the federal estate tax would become a factor. If you take no steps to mitigate your exposure, the portion of your estate that exceeds this amount would be subject to the death tax and its 40 percent maximum rate.
The $5.34 million figure is in place for the rest of this year, but next year you may see a somewhat higher figure after an adjustment for inflation is applied.
If you are exposed to the estate tax, you must implement tax efficiency strategies. Your home is probably one of your biggest assets. You could reduce the taxable value of your home by placing it into a qualified personal residence trust.
Tax Efficient Property Transfer
To implement this strategy, you fund the trust with your home, and you name a beneficiary who will inherit the home after the trust term expires. Presumably this would be your child or children.
When you are creating the trust agreement, you stipulate a term during which you will remain in the home as usual. You don’t have to move or otherwise disrupt your day-to-day life to take advantage of this opportunity.
We have a federal gift tax that is unified with the estate tax to prevent people from giving away assets while they are living to avoid the death tax. The act of funding the trust with the home is considered to be an act of taxable gift giving.
However, the taxable value of the gift is going to be far less than the true value of the house. This is because of the fact that you are retaining incidents of ownership as you continue to live in the home throughout the term of the trust.
If you were to sell the home under the stipulation that you are going to stay in it for 10 or 15 years, it would not sell for its true fair market value. This is why the Internal Revenue Service would reduce the taxable value of the gift.
The longer you stay in the home, the lower the taxable value of the home is going to be. This can lead you to believe that you should stay in the home as long as possible. You have to be careful with this line of thinking, because the strategy completely fails if you die before the trust term expires. If you were to pass away before the term expired, the home would once again become part of your taxable estate.