Lower Real Estate Values Could Be Benefit in Estate Planning
There might be a silver lining to the lowered real estate values, at least when it comes to estate planning that has been delayed too long.
There has been a lot of talk in the past about the greatest transfer of wealth in the world’s history that is occuring right now. As aged parents pass away, many Baby Boomers are trying to escape estate taxes that they had not anticipated.
In some cases, an aged parent might try to quickly (and cheaply) make a gift of a home to their child by simply doing a quit claim deed. There are two main problems with this estate planning strategy: (1) a quit claim deed voids title insurance and (2) the gift of a house means that there quite possibly is a gift tax issue.
One strategy that works very well right now is to start with the current fair market value of the home. Don’t wait too long on this part. The home value is probably at the lowest it’s going to be for a long, long time. I recommend that you pay for an appraisal to make sure you’re starting with the correct amount.
The parent then sells the home to the child. The child grants back a life estate in the house or rents the home to the parents, so the parent never has to leave. So far, so good.
Now, here’s the fun part. The loan is what is called a Self-Cancelling Installment Note. There is a fair interest rate attached to it. In today’s market 6% would work. Then, each year the annual interest amount due plus principal equal to the gift exclusion amount (currently $12,000 per person) is forgiven. If a husband and wife are selling to a husband and wife, there could be a total forgiveness of $48,000 per year.
Upon death, the rest of the note is forgiven.
You have now transferred the house to the children with little or no estate or gift tax.
You can also do variations of this: for example, the child might need to supplement income of a parent. In this case, buying the home with real payments to the parent and charging back a rent that is lower can create some positive cash flow for the parent.
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Very interesting strategy. I think there are a lot of people out there are interested in these types of estate planning issues.
So basically, the strategy is to take today’s tax basis of the home at FMV via the note instead of waiting until death where the basis would be the future FMV with estate taxes based on the entire estate value. Would you apply this transfer approach for someone whose estate isn’t likely to exceed the threshholds for estate taxes?
Could you also just choose to forgive/gift an amount under the $12k per year in order to generate a specific income for the elderly parent?
For families with fewer assets that have to consider Medicare/Medicaid eligibility and wouldn’t be affected by estate taxes, how would owning a note instead of a house affect a person’s eligibility?
You’d have different strategies depending on the wealth of the parents.
Estate planning itself is very up in the air because a number of provisions expire in 2010. What happens in 2011? Who knows?
The gifting works where there is an estate tax concern.
If the issue is Medicaid eligibility, you need to be aware of the 5 year look back rule In other words, if a parent impoverishes by giving assets to his children, Medicaid will look back 5 years to see what was given away and add it back in for calculating benefits.