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By John M. Bigler One of the few times you might look over your financial situation and decide you've amassed too much is when you realize how much of what you own will have to go to pay estate taxes at the end of your life.
Estate planning addresses the "problem" of having too many assets. A large part of estate planning revolves around what to do with your house. Apart from the high value of a house, which can be several hundred thousand dollars, it's difficult to break up a house into bite-sized pieces to make gifts of during your lifetime. Even if you could, that might not be very helpful because it's your house and you just might want to go on living there yourself.
Another possibility might be a grantor retained interest trust (GRIT). This combines some of the benefits of each of the previously discussed options. A GRIT allows you to transfer your wealth to your children or others now but retain the use of your home for a fixed number of years. This would involve giving the home to an irrevocable trust and naming the grantor as the beneficiary of the trust for a set period of time. The grantor chooses the length of time he will also be the beneficiary of the trust. At the end of that time, whoever the grantor intended to ultimately own the property becomes the beneficiary of the trust and the property is eventually distributed out to them from the trust.
This method of transferring assets has many benefits. You can avoid estate and gift taxes on the future appreciation in value of your home and you can make this transfer as a smaller taxable gift than if the home were simply given outright.
The value of your gift is the value of the future interest of your residence. This will depend on the current value of the home, the current interest rates and the number of years you wish to retain your interest in the home. In other words, the value of the gift is the full value of the house minus the interest, measured in years, that you are holding onto.
It's important to remember that a GRIT is a way to lessen your tax liability, not to avoid it altogether. When the house is transferred to a GRIT, a taxable gift is made and a gift tax return needs to be filed. The donor may use part of his lifetime unified estate and gift tax exclusion ($1 million in 2002) to offset the tax.
This kind of trust can also be very flexible. The transferor keeps the real estate tax deductions and home mortgage interest deductions from income tax during the term of the trust. There are also fewer complications to selling the house, if that should become necessary. The grantor can even make use of tax-deferred rollover provisions to apply the proceeds to a new house.
There is a bit of a gamble involved in using this kind of trust. If the transferor survives the term of the trust, the full value of the residence is excluded from his estate. However, if he dies before the trust ends, the full value of the property is included in the estate and all benefit is void. Therefore, choosing the length of time the grantor maintains an interest in the property is extremely important. The longer the time chosen, the greater the potential tax benefit. At the same time, choosing a longer period creates a greater risk that there will be no benefit at all. Of course you can make a reasonable guess based on health and actuarial tables, but it's still a risk.
Reprinted with permission of the Suffolk Times © 2002
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There are a number of methods for lessening the estate tax bite on your home, while allowing you to go on living there. You can make a gift of your house, but retain a life estate. This would let you have almost all the benefits of owning your house outright, while making the taxable value of the property less than it would otherwise be. Another option is to transfer the property to an irrevocable asset management trust. This course of action is more targeted toward protecting assets from the high cost of medical care than from the estate tax. It does offer some more flexibility regarding the property than a life estate, because there are fewer drawbacks if you needed to sell the house during your lifetime.