As part of our planning and use of “revocable” or lifetime (“inter vivos”) trusts, I am often asked whether a residence should be transferred into the trust.
The short answer to the question is yes. When a revocable trust is funded, the settlors do typically transfer the residence to the trust. Such transfer allows comprehensive planning by ensuring that all assets pass according to the terms of the trust. Property left out of trust cannot pass according to the terms of the trust. In most cases, a surviving spouse retains the right to live in the home after the first spouse passes, according to the terms of the trust.
Also, under Internal Code Section 1014(b)(9), the “basis” of a home in the trust is the “date of death” value of the home, just as it would have been if not placed in trust. This is because “property acquired from a decedent”, which is entitled to this “step up in basis”, includes any property acquired by bequest, devise, or inheritance, including property passing to a decedent’s estate from the decedent, as well as any property transferred during the decedent’s lifetime into a trust in which the decedent retained the income for life or control over the income for life, and where the decedent had the power at all times before death to revoke the trust. (Also included is any property passing under a general power of appointment exercised by a decedent, per IRC section 2041(b)).
When a residence is placed in trust, the “value” of the residence at the time of transfer is the “basis” of the trust in the property. So long as a settlor is not likely to have a taxable estate, then the loss of the date of death “stepped up” basis is no real loss and is not a reason not to place the home in trust. Further, at any time prior to a trust becoming “irrevocable” (upon death of second spouse in non-taxable couples’ estates), a taxpayer can remove the residence without any taxable consequence, and the “basis” of the property is the same as when it was originally placed in trust.
Further, taxpayers over 55 may exclude up to $250,000 ($500,000 for most married joint return filers) of gain from the sale or exchange of property that the taxpayer has owned and used as the taxpayer’s principal residence for periods of two years or more during the five-year period ending on the date of the sale or exchange. Thus, anyone over 55 will be able to exclude all gain up to half a million and won’t have any income tax consequence. Of course, the trust is a grantor trust, meaning it is not legally separate from you, the settlors, and thus you can transfer out of trust at any time. B
Once the property is in trust, costly probate of the property is avoided, comprehensive planning is achieved, the value in the hands of beneficiaries will be the fair market value at death, and the property will not be subject to creditors after the trust becomes irrevocable. Typically these benefits suggest that a principal residence should be owned by a settlor’s revocable trust rather than by the settlor individually. Otherwise, principle benefits of a revocable trust are lost.
