Revocable Trusts Must Be Funded to be Effective

May 3, 2023

Revocable assets simplify asset management during life and facilitate private asset transfers at death. Therefore, you might think your estate planning is done when you sign the revocable trust agreement. Nevertheless, it’s not done until you fund the trust, advises a recent article, “’It Ain’t Over ‘Til It’s Over’ – Use of a Funded Revocable Trust in Estate Planning” from The National Law Review. Remember, revocable trusts must be funded to be effective.

A trust is a legal agreement allowing one person—the trustee—to hold and manage property to benefit one or more beneficiaries. The person who creates the trust—the grantor—can create a trust during their lifetime and modify or terminate the agreement at any time. The grantor is the initial trustee and the initial beneficiary. These dual roles allow the grantor to control the trust assets during their lifetime.

Upon death, the revocable trust becomes irrevocable. The trust agreement directs the distribution of assets and appoints the trustee to manage and distribute assets. Unlike a will, the revocable trust works during your lifetime to hold assets.

Funding the trust is critical for it to perform. Assets must be transferred, with an asset-by-asset review conducted to determine which assets should go into the trust. The assets should then be transferred—usually by title or deed changes—which your estate planning attorney can help with.

A funded revocable trust avoids having the assets go through probate. State statutes and regulations require several steps to be completed, adding time, effort and cost to estate administration. Suppose that the revocable trust at death owns the assets. In that case, the trust owns the legal title to the assets, and assets can be distributed to beneficiaries without court intervention.

Avoiding probate also reduces expenses. The expense of probate administration arises from two sources: probate fees and attorney fees. These vary by state and jurisdiction. However, they can add up quickly. A funded revocable trust minimizes both types of fees.

Unlike the will, which becomes a public document once it goes through probate, revocable trust assets and beneficiaries remain confidential, known only to the trustee and beneficiaries. Anyone who wants to can request and review your will and obtain information about assets and beneficiaries. However, the trust is a private document, protecting your loved ones from scammers, overly aggressive salespeople, and nosy relatives.

Privacy can be essential for business owners. For example, suppose you die owning a business interest as an individual. In that case, the description and value of business interests must be reported on the public record during the probate process and is available to potential purchasers to use as leverage against your estate. Transferring business interests to a revocable trust during your lifetime can keep that information private.

Trusts are also used for asset protection for assets with beneficiary designations, including life insurance, IRAs and retirement plans. For instance, if a life insurance policy is paid to your estate, creditors of your estate may have access to the proceeds. If it is paid to the trust, it is protected from creditors. A Revocable trust is only as good as its funding. Revocable trusts must be funded to be effective. If you would like to learn more about RLTs, please visit our previous posts.

Reference: The National Law Review (March 3, 2023) “’It Ain’t Over ‘Til It’s Over’ – Use of a Funded Revocable Trust in Estate Planning”

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Life Estate can be a Cost Effective Option

April 27, 2023

A life estate can be a cost effective option for couples. The person who holds the life estate is known as the life tenant. He or she is entitled to live in and use the properly as they see fit. However, they don’t have the right to sell or transfer the property to someone else.

Realty Biz News’ recent article entitled, “What is a Life Estate and How to Use It,” explains that a recorded deed will reference that a property is a life estate and name the life tenant. Once the life tenant passes away, the property passes to the remainderman—those who will inherit the property after the life estate ends. Let’s look at some of the reasons why someone might want to have a life estate:

Estate Planning. By transferring property into a life estate, the original owner can ensure that the property will pass to a designated beneficiary without probate. It can be particularly useful for people who want to avoid the time, expense and complexity or the probate process.

Asset Protection. The original owner can protect the property from creditors and other potential liabilities by transferring the property into a life estate. This is useful for those in high-risk professions or with significant debts or legal issues.

Family Dynamics. A life estate can also be used to address family dynamics and ensure that everyone is taken care of. For example, a parent might create a life estate to ensure that their adult child can live in the family home for the remainder of their life without giving them outright ownership of the property.

Tax Planning. By transferring property into a life estate, the original owner can reduce their taxable estate and potentially lower their estate tax liability. This can benefit individuals with large estates who want to minimize their heirs’ tax burden.

When a life estate is created, the property is divided into two parts:

the life estate; and
the remainder interest.

The life tenant has the right to use and enjoy the property during their lifetime. The remainderman has the right to inherit the property after the life estate ends.

Remember, with a life estate; the ownership is broken down into possession and ownership. The life tenant has possession and ownership until they pass away; the remainderman has ownership only. When the life tenant passes away, the property passes to the remainderman, who becomes the new owner. The remainderman has the right to sell, transfer, or otherwise dispose of the property as they see fit. Speak with your estate planning attorney to see if a life estate can be a cost effective option for your family’s planning. If you would like to learn more about life estates, please visit our previous posts.

Reference: Realty Biz News (March 20, 2023) “What is a Life Estate and How to Use It”

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Step-Up in Basis can help Avoid or Reduce Taxes

April 25, 2023

Step-up in basis, also known as stepped-up basis, is a wrinkle in the federal tax code that can help heirs avoid or reduce taxes on inherited assets. This aspect of the tax code changes the value—known as the “cost basis”—of an inherited asset, including stocks or property. As a result, the heir may receive a reduction in the capital gains tax they must pay on the inherited assets. For others, according to the recent article, “What Is Step-Up In Basis?” from Forbes, it allows families to avoid paying what would be a normal share in capital gains taxes by passing assets across generations. Estate planning attorneys often incorporate this into estate plans for their clients to minimize taxes and protect assets.

Here’s how it works.

If someone sells an inherited asset, a step-up in basis may protect them from higher capital gains taxes. A capital gains tax occurs when an asset is sold for more than it originally cost. A step-up in basis considers the asset’s fair market value when it was inherited versus when it was first acquired. This means there has been a “step-up” from the original value to the current market value.

Assets held for generations and passed from original owners to heirs are never subject to capital gains taxes, if the assets are never sold. However, if the heir decides to sell the asset, any tax is assessed on the new value, meaning only the appreciation after the asset had been inherited would face capital gains tax.

For example, Michael buys 200 shares of ABC Company stock at $50 a share. Jasmine inherits the stock after Michael’s death. The stock’s price is valued at $70 a share by then. When Jasmine decides to sell the shares five years after inheriting them, the stock is valued at $90 a share.

Without the step-up in basis, Jasmine would have to pay capital gains taxes on the $40 per share difference between the price originally paid for the stock ($50) and the sale price of $90 per share.

Other assets falling under the step-up provision include artwork, collectibles, bank accounts, businesses, stocks, bonds, investment accounts, real estate and personal property. Assets not affected by the step-up rule are retirement accounts, including 401(k)s, IRAs, pensions and most assets in irrevocable trusts.

If someone gives a gift during their lifetime, the recipient retains the basis of the person who made the gift—known as “carryover basis.” Under this basis, capital gains on a gifted asset are calculated using the asset’s purchase price.

Say Michael gave Jasmine five shares of ABC Company stock when it was priced at $75 a share. The carryover basis is $375 for all five stocks. Then Jasmine decides to sell the five shares of stock for $150 each, for $750. According to the carryover basis, Jasmine would have a taxable gain of $375 ($750 in sale proceeds subtracted by the $375 carryover basis = $375).

The gift giver is usually responsible for any gift tax owed. The tax liability starts when the gift amount exceeds the annual exclusion allowed by the IRS. For example, if Michael made the gift in 2018, he could avoid gift taxes on a gift he gave to Jasmine that year with a value of up to $15,000. This gift tax exemption for 2023 is $17,000. Talk with your estate planning attorney to see if a step-up in basis can help avoid or reduce taxes. If you would like to learn more about tax planning, please visit our previous posts.

Reference: Forbes (March 28, 2023) “What Is Step-Up In Basis?”

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Safeguarding Digital Assets in Estate Planning

April 12, 2023

The highly secure nature of crypto assets results largely from the lack of personally identifiable information associated with crypto accounts. Unfortunately, this makes identifying crypto assets impossible for heirs or executors, who must be made aware of their existence or provided with the information needed to access these new assets. Safeguarding digital assets in estate planning is critical.

The only way to access crypto accounts after the original owner’s death, as reported in the recent article “Today’s Business: Cryptocurrency and estate planning” from CT Insider, is to have the password, or “private key.” Without the private key, there is no access, and the cryptocurrency is worthless. At the same time, safeguarding passwords, especially the “seed” phrases, is critical.

The key to the cryptocurrency should be more than just known to the owner. The owner must never be the only person who knows where the passwords are printed, stored on a secreted scrap of paper, on a deliberately hard-to-find thumb drive, or encrypted on a laptop with only the owner’s knowledge of how to access the information.

At the same time, this information must be kept secure to protect it from theft. How can you accomplish both?

One of the straightforward ways to store passwords and seed phrases is to write them down on a piece of paper and keep the paper in a secure location, such as a safe or safe deposit box. However, the safe deposit box may not be accessible in the event of the owner’s death.

Some people use password managers, a software tool for password storage. The information is encrypted, and a single master password is all your executor needs to gain access to secret seed phrases, passwords and other stored information. However, storing the master password in a secure location becomes challenging, as information cannot be retrieved if lost.

You should also never store seed phrases or passwords with the cryptocurrency wallet address, which makes crypto assets extremely vulnerable to theft.

This information needs to be stored in a way that is secure from physical and digital threats. Consider giving your executor, a trusted friend, or relative directions on retrieving this stored information.

Another option is to provide your executor or trusted person with the passwords and seed phrases, as long as they can be trusted to safeguard the information and are not likely to share it accidentally.

Passwords and seed phrases should be regularly updated and occasionally changed to ensure that digital assets remain secure. If you’ve shared the information, share the updates as well.

A side note on digital assets: the IRS now treats cryptocurrency as personal property, not currency. The property transaction rules applying to virtual currency are generally the same as they apply to traditional types of property transfers. There may be tax consequences if there is a capital gain or loss.

Properly safeguarding seed phrases and other passwords for your digital assets is critical in estate planning. Include digital assets in your estate plan just as a traditional asset. If you are interested in reading additional posts regarding digital assets, please visit our previous posts.

Reference: CT Insider (March 18, 2023) “Today’s Business: Cryptocurrency and estate planning”

Asset Protection Trusts can address Long Term Care

April 5, 2023

Asset protection trusts can address long term care costs. As the number of people aged 65 plus continues to increase, more seniors realize they must address the cost of long-term health care, which can quickly devour assets intended for retirement or inheritances. Those who can prepare in advance do well to consider asset protection trusts, says the article “Asset protection is major concern of aging population” from The News Enterprise.

Asset protection trusts are irrevocable trusts in which another person manages the trust property and the person who created the trust—the grantor—is not entitled to the principal within the trust. There are several different types of irrevocable trusts used to protect assets. Still, one of the more frequently used irrevocable trusts for the purpose of protecting the grantor’s assets is the Intentionally Defective Grantor Trust, called IDGT for short.

As a side note, Revocable Living Trusts are completely different from Irrevocable Trusts and do not provide asset protection to grantors. Grantors placing their property into Revocable Living Trusts maintain the full right to control the property and use it for their own benefit, meaning any assets in the trust are not protected during the grantor’s lifetime.

IDGTs are irrevocable, and grantors have no right to principal and may not serve as a trustee, further limiting the grantors’ access to the property in the trust. Grantors may, however, receive any income from trust-owned property, such as rental properties or investment accounts.

During the grantor’s lifetime, any trust income is taxed at the grantor’s tax bracket rather than at the much higher trust tax bracket. Upon the grantor’s death, beneficiaries receive appreciated property at a stepped-up tax basis, avoiding a hefty capital gains tax.

While the term “irrevocable” makes some people nervous, most IDGTs have built-in flexibility and protections for grantors. One provision commonly included is a Testamentary Power of Appointment, which allows the grantor to change beneficiary designations.

IDGTs also include clauses providing for the grantors’ exclusive right to reside in the primary residence. However, if the grantor needs to change residences, the trustee may buy and sell property within the trust as needed.

IDGTs provide for two different types of beneficiaries: lifetime and after-death beneficiaries. Lifetime beneficiaries are those who will receive shares of the total estate upon the death of the grantor. Lifetime beneficiary provisions are important because they allow the grantor to make gifts from the trust principal. Hence, there is always at least one person who can receive the trust principal if need be.

Asset protection trusts are complicated and require the help of an experienced estate planning attorney. However, when used properly, asset protection trusts can address unanticipated creditors, long-term care costs and even unintended tax liabilities. If you would like to learn more about asset protection, please visit our previous posts.

Reference: The News Enterprise (March 4, 2023) “Asset protection is major concern of aging population”

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Take Care when using a Self-Directed IRA

March 29, 2023

For some people, a self-directed IRA could be a great vehicle in which to invest tax-advantaged retirement funds in real property. However, there are rules governing everything from property ownership and usage to how you cover expenses and take profits. If they aren’t followed, you can easily run afoul of the IRS. Take care when using a self-directed IRA.

Forbes’ recent article entitled “How To Use A Self-Directed IRA For Real Estate Investing” explains that a real estate IRA is just another name for a self-directed IRA that’s designed to hold investment property. You can own a wide range of property types in a real estate IRA. This includes land, single and multi-family homes, international property, boat docks, commercial properties and more. Because this is a type of self-directed IRA, the custodian—the company safeguarding your account and enforcing IRS regulations—allows you to hold alternative asset classes, like real estate.

First, find a custodian that allows or even specializes in real estate IRAs. Next, you need to fund your account—typically with a rollover from an existing IRA. With your cash in place, you can buy real estate and have it titled in the name of your IRA. You can finance real estate in your IRA with an investment property-specific mortgage. You can then pay the mortgage using additional cash from your self-directed IRA. When you sell a property held in a real estate IRA, the funds stay in the account. Depending on the type of IRA you’ve selected, those funds grow tax-deferred (traditional IRA) or tax-free (Roth IRA).

A real estate IRA allows you to diversify away from stocks and bonds. However, there are many rules governing this specialized type of account. Let’s look at some of the key rules you must know:

Property Title. Real estate that is held in a self-directed IRA is owned by the account, rather than by you personally. Therefore, the title documents that confirm ownership of the property are in the name of your IRA, rather than in your name.

Expenses and Income. All expenses and income flow into and out of your real estate IRA. All property taxes, utility bills and other expenses are paid by your account. All rental income or other income is paid back into your account.

Limitations on Use. Real estate held in a self-directed IRA can only be an investment property. You and any member of your family—plus any of your beneficiaries or fiduciaries—are referred to as disqualified persons. Since the purpose of an IRA is retirement investing, these disqualified persons can’t make use of the real estate assets.

No DIY. If you need to fix up or repair property held in a real estate IRA, the account must pay for the work. It can’t be performed by a disqualified person (you).

Prior Property Ownership. You can’t sell, lease, or exchange property you already own to your real estate IRA. That’s called “self-dealing,” which the IRS strictly prohibits.

Watch Out for the UBIT. If you take out a loan that’s secured by the property itself (a non-recourse loan), you will be required to pay unrelated business income tax (UBIT) on any profits related to the financed portion. However, you can use depreciation and operating costs to reduce your tax bill, which can allow you to reduce your UBIT or eliminate it altogether.

A self-directed IRA can be a wonderful tool to utilize retirement funds for real estate, but take care when using it. If you would like to learn more about retirement accounts and estate planning, please visit our previous posts.

Reference: Forbes (Feb. 13, 2023) “How To Use A Self-Directed IRA For Real Estate Investing”

Include your Memorabilia in your Estate Planning

March 20, 2023

Do you have a shoebox full of old baseball cards? Or perhaps an old collection of action figures from the many Star Wars movies? This memorabilia certainly has value to you, and you may want to pass it down to your family. The best solution is to include your memorabilia in your estate planning. Kiplinger’s recent article entitled “Estate Planning for Memorabilia Collectors: Don’t Leave Your Family in the Lurch” says the first step is to know what you have. Make a thorough and updated inventory to help your family understand the scale of the collection and where the items are located. Make sure the inventory is current and has detailed information about the items, like if a piece of memorabilia is signed or if it was game-used.

It’s also wise to log valuations along with the items’ description. You can try to stay on top of when comparable items sell at auction and follow industry publications to keep your valuations as current as possible. Every sector of collectible is different. Some items see their valuations fluctuate more than others. Even so, it’s helpful to have a ballpark idea of the total value of the collection. At some point, it might be worth hiring an appraiser to give you a formal valuation of the collection.

As far as authentication, many items need supporting paperwork to verify they’re legitimate. As you plan for your family to handle the sale of your items, they’ll need to know that those documents are an essential part of the collection and where they are.

When you’re walking them through your inventory, note where the items are identified as having separate certificates of authenticity and make sure they know where to find them. This can be as simple as using file folders.

When it comes time to sell, where does your family go Whether it’s sports memorabilia, coins, stamps, or just about anything else, there are dealers who are willing to purchase the collection. If you go into a collectibles shop that’s only buying items they plan to resell, you can expect to get about half of a collection’s actual value.

You can help your loved ones by making connections with auction houses that would be interested in bringing your collection up for sale. This can be a highly specialized area, so you’ll be saving your beneficiaries a big pain if you give them information about where they will get a fair price. Speak with your estate planning attorney about how to include your memorabilia in your estate planning. If you would like to learn more about managing personal property, please visit our previous posts.

Reference: Kiplinger (Feb. 26, 2023) “Estate Planning for Memorabilia Collectors: Don’t Leave Your Family in the Lurch”

Irrevocable Grantor Trust can reduce Tax exposure

March 16, 2023

Forbes’ recent article entitled “How To Pass On Business Assets While Paying As Little In Taxes As Possible” says that one of the first steps you’ll likely undertake in an estate plan is gifting assets so they’re not part of your estate. By gifting assets expected to appreciate over time—like company stock and real estate—into an irrevocable grantor trust and having those assets appreciate outside of your estate, you can reduce your estate tax exposure. Remember: the amount you can gift is restricted to you and your spouse’s combined lifetime federal estate and gift tax exemption ($25,840,000 in 2023).

As the grantor of the irrevocable grantor trust, you’ll be taxed on all income in the trust despite not receiving any of it. However, the payment of taxes from your estate reduces the value of your estate proportionately. Therefore, the assets in the trust can grow unburdened by taxation.

A drawback of gifting appreciating assets into a grantor trust is that the assets will retain the tax basis you, as the grantor, had when you gifted the assets. As the assets are no longer a part of your estate when you die, the assets you transferred to the grantor trust won’t get a step-up in basis to what their value is at that time. Capital gains taxation occurs when the trustee or beneficiary sells the appreciated assets.

Assuming that one of your goals for establishing the trust is to pay as little tax as possible, there are a few ways to avoid capital gains taxes inside a grantor trust.

As the grantor, you have the power to take trust assets back by buying them with cash or replacing them with other assets—low-appreciation ones are ideal. Therefore, if you get a large amount of your employer’s publicly traded stock, you might swap these shares for other publicly traded securities of equal value that have appreciated.

Since the assets traded must be equal in value, there shouldn’t be a change to your estate’s value used for calculating estate taxes. After the trade, you’ll own the highly appreciated stock. However, there won’t be a taxable gain when you pass away because you’ll get a step-up on the basis.

Likewise, for grantor trusts with appreciated real estate, an IRC §1031 exchange allows for capital gains taxes to be deferred when swapping one real estate investment property for another. Discuss with your estate planning attorney how an irrevocable grantor trust can reduce your estate tax exposure. If you would like to learn more about trusts and tax planning, please visit our previous posts.

Reference: Forbes (Dec. 22, 2022) “How To Pass On Business Assets While Paying As Little In Taxes As Possible”

Consider Annuities in your Estate Planning

March 2, 2023

Many people have annuities tied to their retirement accounts. It might be wise to consider annuities in your estate planning. Annuities are contracts between you and an insurance company, which is unlike retirement investment accounts like 401(k)s or individual retirement accounts (IRAs).

Forbes’ recent article entitled “What Is An Annuity Beneficiary?” explains that, with an annuity, you make a lump sum payment or a series of payments over a set period to the insurance company. In exchange, the insurance company will pay out a stream of income in retirement or at a predetermined future date, depending on the type of annuity purchased.

There are a number of benefits to annuities, such as a predictable income in retirement, tax-deferred growth and a death benefit if you pass away. There are several different types of annuities, but they can be grouped into three main categories:

Fixed annuity. If you buy a fixed annuity, the insurance company will pay you a minimum rate of interest and a fixed amount of periodic payments. These are the safest type of annuity because you know the minimum you’ll earn.
Indexed annuity. This combines features of annuities and investment securities. The insurance company’s payments are based on the performance of a stock market index, such as the S&P 500. When the index performs well, the value of the indexed annuity increases. However, it can also decline along with the index’s performance.
Variable annuity. With this type of annuity, you can use your annuity payments for investment products, like mutual funds. Your payout is based on the performance of how much you invest and the rate of return on those securities. These annuities can be risky. However, they have the potential for higher returns.

Whoever signs an annuity contract is considered the owner, who selects the way the annuity will be funded, how payouts will be made and the recipient of the payouts. They also name beneficiaries, control withdrawals and have the power to cancel the contract. An “annuitant” is the person who gets income payments from an annuity contract.

Some annuities have death-benefit provisions, so you can name someone to inherit the remaining annuity payments if you die before it’s been fully paid. The designated recipient of that benefit is known as the annuity beneficiary.

The death benefit of an annuity is typically the remaining contract value or the amount of premiums, minus any withdrawals, upon the annuity holder’s death. Discuss with your estate planning attorney whether or not you should consider annuities as part of your estate planning strategy. If you would like to learn more about annuities and how they work, please visit our previous posts.

Reference: Forbes (Jan. 19, 2023) “What Is An Annuity Beneficiary?”

Consider Portability as a Solution for your Surviving Spouse

March 1, 2023

If you expect to have a large portion of your unused estate tax exemption remaining, you might consider portability as a solution for your surviving spouse. Portability is a process in which any unused estate tax exemption can be transferred from the deceased spouse to the surviving spouse, according to a recent article from Ag Web, “Use Portability to Avoid a Potential Multi-Million Dollar Estate Mistake.”

What portability helps the surviving spouse to achieve is to put their assets in the best position to be transferred upon their death, to the next generation, with little or no estate taxes being owed.

In 2023, each spouse has a $12.92 million exemption from federal gift and estate taxes, but this high amount is set to drop about $6.6 million per person in 2026. Electing portability now will lock in the high exemption if a spouse dies before December 31, 2025, when the high exemption level ends.

The portability election does not happen automatically, and its critical to take this action, even if all assets were jointly owned and no taxes are owed when the first spouse dies. To elect portability, the surviving spouse must file form 706 Federal Estate Tax Return with the IRS.

Many financial advisors may not believe electing portability is necessary. However, it is. One estate planning attorney advises financial advisors and CPAs to obtain a written document affirming their decision from surviving spouses, if they decline to elect portability.

Portability is relatively recent to married farming couples. This is why many people in the agricultural sector may not be aware of it. An estate planning attorney can help the surviving spouse to file a Form 706. The value of assets may be estimated to the nearest quarter million dollars of value at the first spouse’s death.

Form 706 must be submitted to the IRS within nine months of the first spouses’ death. The deadline can be extended with the use of Form 4768 for an additional six months. However, if the surviving spouse misses the initial deadlines for filing, they can still elect portability up to five years from the date of their spouse’s death, by invoking “Relief under Revenue Procedure 2022-32.”

There were so many applications for extensions made to the IRS that in 2022, the change was made to give surviving spouses more flexibility in applying for portability.

Talk with your estate planning attorney to consider portability as a solution for your surviving spouse. If you would like to learn more about portability, please visit our previous posts.

Reference: Ag Web (Jan. 30, 2023) “Use Portability to Avoid a Potential Multi-Million Dollar Estate Mistake.”

Category: Asset Protection

Revocable Trusts Must Be Funded to be Effective

Life Estate can be a Cost Effective Option

Step-Up in Basis can help Avoid or Reduce Taxes

Safeguarding Digital Assets in Estate Planning

Asset Protection Trusts can address Long Term Care

Take Care when using a Self-Directed IRA

Include your Memorabilia in your Estate Planning

Irrevocable Grantor Trust can reduce Tax exposure

Consider Annuities in your Estate Planning

Consider Portability as a Solution for your Surviving Spouse

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