Most people are not faced with estate tax exposure, because the credit or exclusion is relatively high. For the rest of 2014, this exclusion sits at $5.34 million. In 2015, it increases to $5.43 million. You can leave unlimited assets to your spouse free of taxation, but the estate tax would be a factor on transfers to other people if the transfers exceed the estate tax exclusion.
The estate tax currently carries a top rate of 40 percent, so you should be proactive about the implementation of estate tax efficiency strategies if your estate is in taxable territory.
In addition to the federal estate tax, there is also a federal gift tax. Together they are referred to as transfer taxes. The transfer tax exclusion is a unified exclusion. It encompasses taxable gifts that you give while you are living along with the value of your estate.
Qualified Personal Residence Trusts
Since your home is probably one of your most valuable assets, you could gain a great deal of estate tax efficiency if you could reduce its taxable value. This is where a qualified personal residence trust (QPRT) can enter the picture.
Here’s how it works. You convey your home into the trust, and you name a beneficiary who will assume ownership of the property after the term of the trust expires.
When you are creating the trust agreement, you decide on the length of the term, which is referred to as the retained income period. You remain in the home as usual during this interim, so you are not surrendering control of the property, and your life is not disrupted.
The value of the property is removed from your estate for tax purposes when you convey it into the trust. However, you are giving a taxable gift to the beneficiary, because ownership of the house will change hands when the retained income period comes to a close.
You save on taxes because the taxable value of the home will be far less than its actual fair market value. This is because of the retained income period.
No buyer would pay full market value for the home under the stipulation that you will be remaining in it for 10 or 15 years. The IRS factors this into the equation when the taxable value of the home is being calculated.
The strategy disintegrates and the home goes back into your taxable estate if you die before the expiration of the trust term. Though the tax savings are tied to the duration of the term, you should take this into consideration when you are deciding on the length of the retained income period.
If you have concerns about taxation or any other estate planning matter, please contact our office.