Why are titles to millions of U.S. houses and condominiums held in their owner’s living trusts?  Could it be those owners know about the living trust benefits which the rest of us need to learn?  Why would a homeowner spend $400 to $1,000, sometimes more, to hire an attorney to create their living trust to avoid probate costs and delays for their heirs?

Yes, you can create a simple living trust by using the tear-out forms in some of the books listed at the conclusion of this report, but hiring an attorney might be well worth the modest cost.  What would you do if you or your residence co-owner spouse suffered an incapacitating serious stroke, or contracted Alzheimer’s disease, and your home had to be sold to pay for long-term care – how could you sell the home if your spouse who is also on the title is unable to communicate or sign the deed?

Those are just a few of the questions that will be answered in this important report.  As long-time subscribers know, I’ve revisited the topic of living trusts many times.  I do this for several primary reasons:  (1) living trusts are, by far, the most popular real estate topic which I write about, (2) there is always more to learn about the pros and cons of living trusts, and (3) most people don’t discover living trust benefits until it is too late – usually after a loved one has died or become incapacitated, and the relatives have to deal with probate costs and delays which can be completely avoided with a living trust.

In 1966, Norman F. Dacey wrote the best-seller book How to Avoid Probate! (Crown Publishers, New York).  For revealing the secrets of living trusts and providing tear-out forms in his book to avoid probate costs and delays, Dacey was enjoined by the Connecticut Bar Association.  In New York, Dacey was charged with criminal contempt of court for having written the book!  He was found guilty and ordered to pay a $250 fine or spend 30 days in jail.  But he appealed all the way to the New York Court of Appeals, which reversed finding Dacey not guilty.  Within 13 weeks, his book became the nationwide number one best-selling book, displacing the famous Masters and Johnson book Human Sexual Response.  Over 1,500,000 copies of Dacey’s book were eventually sold.

Just in case you think avoiding probate costs and delays for your estate is not important, here are some famous examples:  (1) Elvis Presley reportedly left a $10.2 million estate when he died, but estate administration costs were $7.2 million, leaving only 28% of his assets for his heirs; (2) Even penny-pincher John D. Rockefeller’s probate costs consumed 64% of his gross estate; (3) Marilyn Monroe left a $1 million estate which was depleted by attorneys and others down to only $101,000 which was distributed to her heirs 18 years after her death; (4) A 1997 U.S. Tax Court decision approved attorney fees of $1,600 per hour for a total of $368,100 in an estate case which said those fees were “reasonable under New York law;” (5) Multi-millionaire J. Paul Getty’s estate is still not yet closed but attorney, accounting, property management, appraisal, and sales contracts continue depleting the estate assets: (6) Bill Lear, inventor of the Learjet, died in 1978 but his will is still being contested in court today; and (7) actor John Wayne died in 1979, but his estate is still tied up in Probate Court as his relatives argue about who will get his assets.  I could go on, but you get the idea.

Why didn’t those famous estates involve living trusts?  Could it be because the lawyers were looking forward to their lush probate fees when the will testator died?  Maybe that’s why many lawyers charge very low fees to prepare a will, sometimes only $50 or $100, often naming themselves as attorney for the estate.

EXAMPLE:  Before my mother passed away a few years ago, she told me her Minnesota attorney who prepared her will advised her not to transfer the title to her Minnesota condominium into her living trust.  He said doing so would forfeit her Minnesota homestead property tax exemption (which saves about $1,000 property tax each year).  Since I’m a California attorney, not familiar with Minnesota state laws, I presumed her attorney was correct.  After she died, her only asset that had to pass through Probate Court under the terms of her will was her condominium.  When I contacted another Minnesota attorney at the excellent firm of Moss and Barnett to handle the easy probate, I was shocked to learn mom’s first attorney was wrong and her condo could have been in her living trust without losing her homestead exemption.  But he was dead, so I couldn’t confront him!  It took almost a year for a simple probate to transfer title to her condo. Most of the legal paperwork was performed by a very capable paralegal.  Including two brief court appearances by the attorney, only a few hours of work was necessary.  The cost – about $1,700, which could have been avoided by use of a living trust.

Did you know that attorney fees for probate costs are set by state law in most states?  The Kiplinger Washington Letter reported probate fees for small estates can be as high as 22% of the deceased’s assets and as little as 6.2% for estates over $300,000. Late Senator and U.S. Attorney General Robert F. Kennedy called probate costs “A political toll-booth exacting tribute from widows and orphans.”  However, probate attorney fees are negotiable so if you ever are involved as an executor or administrator of an estate be sure to negotiate the probate attorney’s fees for this relatively easy work.

THE PRIMARY PURPOSE OF A LIVING TRUST IS TO SAVE PROBATE COSTS AND DELAYS, NOT TO AVOID DEATH TAXES.  Living trusts do NOT save or avoid federal estate or gift taxes, nor do they avoid inheritance taxes in the few states which still have inheritance taxes levied on the person inheriting the asset or cash (Connecticut, Indiana, Iowa, Kentucky, Louisiana, Maryland, Nebraska, New Hampshire, and New Jersey).  Usually, a surviving spouse pays no state inheritance tax.  If possible, try not to die as a resident of one of these states that imposes inheritance taxes on your heirs (unless your situation will be exempt).

Incidentally, some states that abolished inheritance taxes are thinking about reinstituting them.  The reason is until 2002 the federal estate tax law allowed a credit for state inheritance taxes paid.  This is called a “pick up tax” from large estates, which are subject to the federal estate tax.  But this federal credit for state inheritance taxes paid will be phased out by 2005 so watch for states to attempt to reinstate inheritance taxes on the person inheriting money or an asset.

HOW THE FEDERAL ESTATE AND GIFT TAX WORKS.  In 2001, Congress gradually increased the federal estate and gift tax exemptions for future years.  By 2010, the federal estate tax will be eliminated – but only for one year!  That means the best year to die will be in 2010 because your entire estate, regardless of its size, will be exempt from federal estate tax – but only in that year (unless Congress extends the exemption).

The federal estate tax exemption was $675,000 for decedents dying in 2000 and 2001.  The exemption increased to $1,000,000 for decedents passing away in 2002 and 2003.  In 2004 and 2005, the exemption is $1,500,000.  The exemption increases to $2,000,000 in 2006, 2007, and 2008.  In 2009, the exemption jumps to $3,500,000.  The federal estate tax will be fully repealed only for decedents dying in 2010.  In 2011, unless Congress acts, the $1,000,000 estate tax exemption returns as do the higher pre-2002 estate tax rates.

FEDERAL GIFT TAX RULES.  But the lifetime gift tax exclusion remains at $1,000,000 for 2002 and years thereafter.  After 2009, the top gift tax rate will equal the top personal income tax rate, scheduled to be 35%.

Under current federal gift tax law, individuals can give away up to $11,000 per donee per year to as many persons as desired without owing any gift tax or filing any gift tax return.  That means a husband and wife, for example, can give a total of $22,000 ($11,000 from each donor) to as many individuals as they wish each year.  But annual gifts exceeding $11,000 per donor per donee require filing a federal gift tax return.  However, no federal gift tax is due if the donor’s lifetime total gifts exceeding the $11,000 annual threshold total $1,000,000 or less. 

EXAMPLE:  Suppose you filed lifetime gift tax returns (but owed no gift tax) of $400,000 total.  When you die in 2004, that $400,000 is subtracted from your $1,500,000 federal estate tax exemption.  That means if your net estate is lower than $1,100,000 when you die, your estate owes no federal estate tax.  However, if your net estate exceeds $1,100,000 in this example (your $1,500,000 minus $400,000 lifetime reportable gifts) your estate owes federal estate tax on your estate amount exceeding your $1,100,000 remaining exemption.  However, regardless of amount, any assets left to a surviving spouse are exempt from federal estate tax.  But when the second spouse dies, Uncle Sam will be waiting to collect estate taxes on any net amount above the then-current exemption (unless the death occurs in 2010).  Also, any estate transfers to charity are exempt from federal estate tax.

UNDERSTAND THE STEPPED-UP BASIS RULES FOR INHERITED PROPERTY – WATCH FOR THE BIG CHANGE AFTER 2009.  Most inherited property now receives a new “stepped-up basis” to market value on the date of the decedent’s death for the person inheriting it by will, living trust, or intestate succession:

EXAMPLE:  Suppose your mother’s adjusted cost basis for her house was $50,000 (adjusted cost basis is usually the purchase price, plus costs of capital improvements added during ownership, minus any business area depreciation deducted).  When she dies and leaves you her house either by will, living trust, or intestate succession, the house is worth $400,000.  Your new stepped-up basis will be $400,000.  If you then sell the house for $400,000, you have no taxable capital gain.  However, if you keep the house for a while and eventually sell it for $450,000 adjusted (net) sales price, then you will have only a $50,000 capital gain.  However, if before your mother’s death, she gave you a quitclaim deed to her house, you would then take over her low $50,000 basis.  The tax rule is the donee takes over the donor’s basis.  If you then sell that house for $400,000, you would have a $350,000 taxable capital gain because it didn’t get a stepped-up basis by inheritance.  Now you can see why I often say it is better to inherit property than to receive it as a before-death gift.

If a surviving spouse inherits a decedent spouse’s half of a property, the surviving spouse will receive a new stepped-up basis on the inherited half of the house.  However, surviving spouses who held title with the deceased spouse as community property (allowed in the states of Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin) get a new stepped-up basis to 100% of the property’s entire fair market value on the date of the deceased spouse’s death.

But in 2010, unless Congress changes the current tax law by then, the stepped-up basis rule will be limited.  The heir’s basis will then become the decedent’s low basis.  However, an estate executor will be allowed to step-up the basis of inherited assets up to $1,300,000.  Basis of property transferred to a surviving spouse can be increased by an additional $3,000,000 for a potential total of $4,300,000 for a surviving spouse.

METHODS OF AVOIDING PROBATE COSTS AND DELAYS.  But the time-consuming and expensive probate procedure briefly explained above can be completely avoided.  However, let’s first consider the most popular methods some people use to avoid probate proceedings:

1 – Hold title to your assets in joint tenancy with right of survivorship (or tenancy by the entireties – a special version of joint tenancy between husband and wife in the few states allowing it).  California, a community property state, now allows holding title as “community property with right of survivorship” (effective July 1, 2002) to combine the joint tenancy benefits with the community property stepped-up basis benefit on the entire property’s fair market value, as discussed earlier.

When a joint tenant dies, the surviving joint tenant(s) usually needs only record (a) a certified copy of the death certificate and (b) an affidavit of survivorship.  This “poor man’s will” joint tenancy title method is widely used, especially by husbands and wives.  But what happens if one joint tenant becomes incapacitated, such as with Alzheimer’s disease or a disabling stroke?  If the joint tenancy property must be sold or refinanced, but one joint tenant co-owner is unable to sign the papers, a court-appointed conservator or guardian is required.

Holding joint tenancy with right of survivorship title with a non-spouse can lead to unexpected complications.  To illustrate, suppose you add your adult son or daughter (NEVER add a minor child below age 18 to a real estate title because they cannot convey title and they will then require a court-appointed guardian to do so) to your realty title as a joint tenant with right of survivorship.  But then you have a disagreement with your joint tenant and want him off your title.  Or suppose you want to sell or refinance the property, but your joint tenant co-owner refuses to sign the papers.  Worse, if you want to sell, suppose that ungrateful greedy joint tenant demands her share of the sales price in return for signing!

2 – Payable on death checking and savings accounts.  Many banks now permit holders of checking and savings accounts to have “payable on death” clauses in their account records so the assets go automatically upon death to the person named.  However, complications can develop if that person predeceased the account owner who forgot to change their bank account records before dying.

3 – Revocable power of attorney.  During your lifetime, you can appoint a trusted relative or friend to be your attorney-in-fact by using a written power of attorney form.  That means he or she has the authority to sign your name to important papers, such as a deed to your home or other real estate. 

However, an ordinary power of attorney ceases to be effective when you (a) become incapacitated or (b) die.  A “durable power of attorney” for financial management can overcome the first problem, but it won’t enable your attorney-in-fact to distribute your assets after you die.  Probate proceedings will then become necessary.

WHAT IS A REVOCABLE “INTER VIVOS” LIVING TRUST?  A revocable living trust is used by millions of homeowners and real estate investors to completely avoid the costly and time-consuming probate procedures already discussed. 

A revocable “inter vivos” (which means among the living) living trust is a simple method of holding title to real and personal property, such as your house or condo, investment real estate, second or vacation home, common stocks, bonds, home furnishings, automobiles (although many insurance agents and probate attorneys recommend not holding vehicle titles in a living trust), artworks, and other assets to avoid ownership transfer through probate proceedings after the owner dies.

A revocable living trust allows the owner (called the “trustor”) to buy, sell, and deal with their living trust assets just as if title was held in the owner’s name alone.  A living trust can be used to hold title to a property alone.  Or, if you are a co-owner with one or more co-owners, you can own your share of the property in a living trust and the other co-owners can hold their title as they wish, such as tenants in common. 

The major advantage of holding title to your real estate and personal property in a living trust is to avoid probate costs and delays.  After you’re gone, your successor trustee can then quickly pay your debts and distribute your living trust assets according to the terms of your living trust – the probate court doesn’t become involved. 

An equally important secondary living trust advantage is to provide management of living trust assets while a trustor is incapacitated and unable to manage his or her assets.  Just a few days ago, I heard an attorney who specializes in “elder care law” state that one out of every three persons 85 or older either has or will be diagnosed with Alzheimer’s disease.  As millions of “baby boomers” retire, the benefits of living trusts will become more important than ever before.

EXAMPLE:  Although I’ve used this example many times, it’s worth repeating because we all know about this sad situation.  Suppose Ronnie and Nancy, husband and wife, hold their house and other real estate titles in joint tenancy with right of survivorship.  When Ronnie or Nancy dies, probate will be avoided because the surviving joint tenant receives the full title by survivorship.  However, instead of dying, Ronnie has Alzheimer’s disease and is incapacitated.  He doesn’t even recognize his devoted wife.  Suppose Nancy runs short of money to pay for Ronnie’s care (he’s now 93).  She needs to sell their house to pay for Ronnie’s expensive care at a convalescent hospital.  But Ronnie doesn’t know what’s going on and is unable to sign his name on the deed.  Nancy will need to have a court-appointed conservator represent Ronnie to sign the deed on his behalf.  However, this would not be necessary if Ronnie and Nancy held title to their home in their living trust.  Then, after a physician certifies Ronnie is unable to understand, as co-trustee Nancy alone can convey title to their home and manage the other living trust assets without Ronnie’s signature.

How much does a living trust cost?  As you probably know, I often write about living trusts in my syndicated newspaper articles because I receive so many questions about them.  (Incidentally, you can now read most of my real estate question and answer mailbag, law, book review, and notebook articles online at www.inman.com, www.washingtonpost.com (they also keep a nice archive of my past articles), and other local newspaper websites.)  By the way, I am now receiving over 500 e-mail and snail mail questions a week so please don’t be offended if I can’t personally answer your question in the “Real Estate Mailbag” columns.

One of the most frequently asked questions, especially at www.bobbruss.com is “How much should a living trust cost?”  The short answer is “It depends how much you want included in your living trust.”  I’ve seen some Florida living trust attorneys advertise fees as low as $395 and $495.  But most probate attorneys charge around $1,000.  If your situation is complicated, you might pay up to $2,500. 

Please be sure the fee includes title transfer of your real estate into your living trust.  There’s nothing worse than paying an attorney to prepare your living trust just the way you want it, but then failing to “fund” it with your real estate and other assets!  Or, if you are a penny-pincher, you can do-it-yourself by using the forms in the books listed at the conclusion of this report.

WHAT IS THE PROCEDURE TO CREATE A LIVING TRUST?  A living trust has three parties:  the TRUSTOR is the person who creates the living trust (husband and wife can be co-trustors of their joint living trust, or they can have separate living trusts), the TRUSTEE is the person holding legal title to the real and personal property assets (husband and wife can be co-trustees), and the BENEFICIARY is the person(s) or charity who will ultimately receive the living trust assets after the initial trustor(s) die.

An additional party is the SUCCESSOR OR ALTERNATE TRUSTEE.  This person might be an adult child, trusted friend, relative, or bank trust department.  After the trustor becomes incapacitated or dies, the successor trustee takes over managing the living trust assets according to the terms of the living trust (which then become irrevocable).  Until you become incapacitated or die, you can amend or even completely revoke your living trust.

When your living trust is created, you are the trustor, trustee, and beneficiary of your living trust assets.  After you create your revocable living trust, and fund it by transferring into it your house or condo, investment realty, bonds, stocks, mutual funds, and vacation residence, you are the initial trustor, trustee, and beneficiary.  That’s why you can continue managing your living trust assets just as you did before creating your living trust.  Buy, sell, refinance, or do anything you want with your living trust assets!

You don’t even need to tell the IRS you have a living trust.  It has no effect on your tax breaks, such as claiming the $250,000 or $500,000 principal residence sale exemption if you meet the two out of last five years ownership and occupancy tests of Internal Revenue Code 121.  Your tax breaks are unchanged when you transfer title to your real estate into your living trust.

Give your successor trustee (or spouse) a durable power of attorney.  In case you become incapacitated, your successor trustee (or spouse) should have the authority to manage ALL your assets, including any which were not transferred into your living trust (such as your automobile).  This can be done with a durable power of attorney for financial management form.

WEALTHY MARRIED COUPLES SHOULD CONSIDER AN A-B TRUST TO AVOID FEDERAL ESTATE TAXES.  Although beyond the scope of this report about living trusts, wealthy married couples that own total assets above the federal estate tax exemptions should consider an A-B trust to be able to pass twice the federal exemption amount upon a spouse’s death. 

The first transfer upon death of all property to a surviving spouse is exempt from federal estate taxes, regardless of amount.  But for tax avoidance after the second spouse’s death, an A-B trust should be considered.  Ask an estate-planning attorney how an A-B trust arrangement can save estate taxes.

SUMMARY.  Living trusts offer many benefits and few drawbacks.  Consultation with an experienced attorney and/or tax adviser who is familiar with living trust benefits is highly advised.  More details and tear-out forms are available in these recent books, available in stock or by special order at local bookstores, public libraries, and www.amazon.com:  Make Your Own Living Trust, 6^th Edition, by attorney Denis Clifford (Nolo Press, Berkeley, CA, 2004, $39.99; includes CD-ROM); Living Trusts Simplified, by attorney Daniel Sitarz (Nova Publishing, Carbondale, IL, 2002, $22.95; Living Trusts, 3^rd Edition, by Doug H. Moy (John Wiley and Sons, Hoboken, NJ, $39.95); and The Living Trust, Revised and Updated Edition, by Henry W. Abts III (Contemporary Books, Chicago, 2003, $39.95).

 

COPYRIGHT 2004 BY ROBERT J. BRUSS

This publication is intended to provide scant and authoritative information. It is sold with the understanding the publisher is not engaged in rendering legal services to readers. If legal or other expert assistance is required, services of a real estate attorney or other professional should be obtained.