Jeremy Taylor
|
Key Highlights
|
Real estate that holds sentimental value for you and your family requires a specialized approach when integrating such assets into a comprehensive estate plan. Estate planning for family real estate assets that may hold sentimental value has unique challenges and considerations. Sentimental real estate may include a family home, vacation home, farm, ranch, or even land with potential mineral or water rights. Managing family dynamics, understanding potential tax implications, and preparing for the distribution and continued management of the property are important matters to address when developing a comprehensive estate plan.
Navigating family dynamics and preferences for sentimental real estate
Understanding the intentions of your beneficiaries is critical when integrating real estate into your estate plan. While some may want to keep the property and others may prefer to sell it, proactively communicating with them will help you make informed decisions. This allows you to shape your estate plan according to your goals and family values, ensuring the property is handled in a way that aligns with your vision.
Family dynamics can complicate estate planning decisions regarding sentimental real estate. Disagreements may arise regarding the property’s future, potentially heightened by the sentimental attachment or memories associated with the property.
Further, emotional attachment may conflict with the financial realities of transferring ownership of a real estate property. For example, you may have a family home that holds emotional value for several family members, but it may be impractical to divide ownership among multiple beneficiaries. Consider employing a neutral third party such as your private wealth management team, to help address potential conflicts early and make decisions about future ownership with objectivity.
Succession planning considerations for sentimental real estate
Formalizing a succession plan for your real estate property can ensure the property is managed in a way that honors its sentimental value while addressing practical considerations like ownership, tax implications, ongoing maintenance, and costs associated with the property. Deciding whether to gift the property during life or bequeath it at death requires careful consideration and professional guidance, as each option has its tax and estate planning implications.
If you decide to legally transfer the ownership or title of your property to an entity like a trust, LLC, or LP, it is important to ensure the property is conveyed properly so it suits your goals. This is often done to seek benefits such as asset protection, tax efficiency, and providing a structured plan for ownership transfer and ongoing management.
Recurring costs and shared-use considerations
Recurring costs for your sentimental real estate property such as maintenance, insurance, and property taxes are important to consider when developing a succession plan. Without adequate liquidity, if your beneficiaries struggle to cover these costs, they may ultimately need to consider selling the property even if the intention was to keep it in the family.
In addition to normal maintenance, you may also want to consider documenting instructions for capital expenditures such as improvements and renovations. Planning for these long-term investments clarifies expectations for your beneficiaries as they take steps to enhance or maintain the property’s value.
If you have multiple beneficiaries, it may make sense to draft a shared-use agreement that outlines how multiple family members will share the use, responsibilities, and expenses of the property. You might also outline instructions for the best use of the property whether it is for investment purposes, future development, or managing natural resources like mineral or water rights.
Tax implications of gifting versus bequeathing your sentimental real estate
Understanding what taxes might be generated, like federal estate and gift taxes or capital gains taxes, from the transfer or sale of your sentimental real estate is important when evaluating whether to gift the property during life or bequeath it at death.
The top tax rate for federal estate and gift taxes is 40%, making the associated tax liability potentially very significant. If you gift the property during your life, the IRS will likely treat it as a taxable gift that either uses a portion of your lifetime exemption from federal estate and gift taxes or incurs a federal gift tax liability if your exemption has been expended.
If instead, you decide to bequeath the property at death, the use of your exemption functions similarly. The fair market value of your assets, including any taxable gifts you gave over your lifetime, will be used to calculate your federal estate tax liability. Generally, a higher total estate value over your remaining exemption amount corresponds to a greater federal estate tax liability.
Planning for what federal estate and gift taxes (and state taxes if applicable) may be owed at your death will help ensure your beneficiaries have enough liquidity to pay such taxes and keep the assets you intended to become part of their own personal wealth. This is an especially important planning consideration if the estate tax exemption sunsets in 2026, which would significantly reduce the historically high exemption amount.
If you bequeath your property at death, it will receive a step-up in cost basis, which can lead to a lower capital gains tax liability if the property is eventually sold. The cost basis, or the original price you paid for the property, is reset to the fair market value of the property as of the date of death. If the property appreciates further and is later sold by your beneficiaries, they would only be taxed on the net gains relative to the new cost basis value.
In contrast, if you gift your real property during your life, it will not receive a step-up in cost basis. Rather it keeps the same cost basis that you, the transferor, held in the property. This means that if the property is later sold at an appreciated value, it could lead to a higher capital gains tax liability for your beneficiaries.
Using a trust to transfer sentimental real estate
If you want greater control over the transfer of your real property, a trust allows you to set terms regarding the property’s distribution and continued management. Depending on the type of trust you use, placing your real estate property in a trust may help you reduce your estate taxes, avoid probate, and protect the property from creditors.
Trusts, however, have some drawbacks when used to transfer real estate as it can be difficult to maintain centralized ownership. For example, a trust could terminate and distribute an undivided ownership interest in the property to ten different beneficiaries, which can make it challenging to maintain cohesive decision-making and management of the property.
Using a limited liability company (LLC) or limited partnership (LP) to transfer and manage sentimental real estate
Using an LLC or LP to transfer real estate allows you to maintain control of the property within a single entity, separate the management of the property from the individual owners, and retain a higher degree of liability protection.
With an LLC or LP, instead of splitting the property amongst your beneficiaries directly, you can distribute ownership in the form of interests in the LLC or LP. This allows beneficiaries to hold an ownership stake without dividing the ownership of the property itself.
An additional benefit of using an LLC or LP in this manner is that you can appoint a specific person to manage the property, which may be more efficient than delegating that responsibility to multiple individual owners.
Your beneficiaries may also have a greater degree of liability protection with an LLC or LP, as these entities can limit the liability associated with the property to the assets of the entity rather than expose the personal assets of the underlying owners.
If you use an LLC or LP to manage your property, it is important to ensure proper administration to maintain legal compliance and uphold its status as an entity with valid business purposes. Otherwise, the entity could lose liability protection for the underlying owners or lead to negative tax implications, potentially undermining the benefits of structuring ownership through an LLC or LP.
Outlining preferences for the property in governing documents
Both trusts and entities like LLCs and LPs may provide an opportunity to formalize instructions for the property’s management like shared use, expenses, improvements, or the future sale of the property in their respective governing documents. If you want the property to remain in the family for multiple generations, you might include provisions governing the disposition of the property. Some families specify conditions, such as a waiting period that allows for thoughtful decision-making or certain criteria that must be met before the property is sold such as requiring unanimous consent among beneficiaries.
While this is an option for those who want greater control over the property’s future ownership, it is important to ensure the entity has sufficient liquidity to cover recurring costs over time. It is also imperative to structure the language in your governing documents so that it is not so restrictive that it becomes difficult to administer or enforce your instructions. Consulting your private wealth management team to review the language in your governing documents could help ensure they align with your goals while allowing enough flexibility to manage your property efficiently for years to come.
Engage a team of wealth specialists to integrate sentimental real estate into a comprehensive estate plan
Estate planning for real estate that holds sentimental value for you and your family requires an understanding of your long-term goals, sensitivity to family dynamics, and specialized knowledge in succession planning for real estate.
At Commerce Trust, our private wealth management teams are comprised of specialists who can advise you on real estate, estate planning, tax management*, and trust administration. Your wealth management team can partner with your estate planning attorney when establishing a trust, LLC, or LP to ensure it functions according to your goals. Commerce Trust can also serve as corporate trustee, assist you in navigating family dynamics, and implement strategies that can help you transfer your sentimental real estate in a tax-efficient manner.
Contact Commerce Trust today to learn more about our comprehensive estate planning services and secure your property for future generations.
*Commerce does not provide tax advice to customers unless engaged to do so.
The opinions and other information in the commentary are provided as of November 7, 2024. This summary is intended to provide general information only, and may be of value to the reader and audience
This material is not a recommendation of any particular investment or insurance strategy, is not based on any particular financial situation or need, and is not intended to replace the advice of a qualified tax advisor or investment professional. While Commerce may provide information or express opinions from time to time, such information or opinions are subject to change, are not offered as professional tax, insurance or legal advice, and may not be relied on as such.
Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Commerce Trust is a division of Commerce Bank.
Investment Products: Not FDIC Insured | May Lose Value | No Bank Guarantee
