How a Living Trust Can Save Your Loved Ones Thousands in Property Taxes

Passing your home down to your loved ones after you pass away might be a dream of yours but this generous act could end up being a taxation nightmare for them. Luckily, you can help your beneficiaries avoid financial heartache by protecting this asset in a living trust. Here’s how to save your loved one thousands of dollars in taxes when they inherit your home and the mistakes you must avoid.

Step-Up Basis Rule

The value of a home typically increases with time but so does the amount of tax you must pay on the gain. However, there is a special rule for inherited properties called the step-up in basis rule, which allows beneficiaries to save thousands in tax fees. Here is an example of how it works: Julie inherits a house from her aunt who bought the house in 1990 for $200,000. The home was worth $800,000 at the time of her aunt’s death. If Julie decides to sell the house, her basis is “stepped-up” to $800,000 so she will only be taxed on any gain recognized what she sold it for and its new basis of $800,000.

“Double” the Step-up in Basis

Since California is a community property state, residents can take advantage of the “Double Step-up in basis” rule with proper planning. Here’s an example of how the double step-up in basis works: John and Mary bought a house in 1990 for $200,000, and they deed the house to their revocable living trust. When John died in 2010, the house remained in the survivor’s trust and Mary got the full step-up basis for the house which was the market value at John’s death of $800,000. When Mary passed away in 2015, the house was worth $900,000 which became the new basis for Mary’s son David who inherited it. In short, David inherited a house that had stepped up in basis twice to $900,000. If David chooses to sell the property for $900,000, he does not pay taxes on the capital gain realized after his father or his mother’s death.

Mistakes to Avoid

Co-ownership

Your children/beneficiaries will not be eligible for the double step-up in basis if they co-own the property with you at the time of your death. Make sure they inherit the real property through a trust so they do not have to realize the capital gain from the appreciation.

Joint Tenancy

If you hold title in joint tenancy with your spouse instead of a holding title through your living trust, the surviving spouse will only realize a ½ step up in basis based on the ½ ownership interest of the deceased spouse. Thus a surviving spouse who may want to sell the home after the first spouse’s death will be forced to pay taxes on the capital gain for the ½ interest that does not receive the step up in basis.

Step-Down Risk

As the housing market crash in 2008 can attest, the value of your home will not always be on the rise. If the value of your home significantly drops at the time of your death, your loved ones may be stuck with the unwanted asset. Plan on making ownership/title adjustments if it appears the home inheritance will become a burden on your loved ones.

Plan With a Professional

You wouldn’t trust a first-year dental student to do your root canal, so why would you count on an amateur financial planner to review your estate plans? Meet with a team of experts who can educate you on the best options based on your individual situation.

At Heritage Law, LLP, our lawyers advise individuals, business owners, and families about the best ways to plan for their future security through wills, trusts, gifts, and other estate planning tools. Our services range from basic estate plan packages to advanced trust instruments suitable for complex tax liability problems or business management succession. 

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