When you are preparing your legacy you not only have to arrange for the transfer of assets to your loved ones, you have to make sure that it happens without losing anything in the process. There are sources of asset erosion that exist, and the one that is most profound is the estate tax. A lot of people are under the impression that the estate tax does not apply to them because they’re not among the upper crust, but in reality you can be exposed to the estate tax even if you would not consider yourself to be wealthy.
This is especially true considering the fact that there are changes to the estate tax parameters pending. If there are no legislative changes enacted in the meantime, at the beginning of 2013 the estate tax exclusion will be reduced from the $5 million that is in place today down to just $1 million. The rate of the tax will go up to 55% from the 35% that is in place as of this writing. So, at the end of next year the portion of your estate that exceeds $1 million in value will be shaved down by over half by the estate tax.
A lot of people who are exposed to the estate tax could stay within the exclusion if there was a way that they could remove the value of their homes from their estates. This can be accomplished through the creation of a qualified personal residence trust. With these vehicles you name a beneficiary who would assume ownership of the home after the trust term expires. You set a term during which you remain in the home, living rent-free as usual. By doing this you remove your home from your estate for estate tax purposes.
The act of funding the trust with the home is considered to be a taxable gift. But, the taxable value of the property is reduced by the interest that you retain in the home by living there. This value is going to be significantly below the true market value of the house. If it is within the gift tax exemption, you will have successfully transferred the property free of taxation while removing it from your estate to gain estate tax efficiency.