Options for Residential Real Estate Planning

After the economic downturn in 2008, individuals may find that residential real estate comprises of a large portion of some of their assets. Given the illiquid nature of real estate, it can be hard to protect and plan for real estate depending on your goals and objectives. This article discusses options for planning with residential real estate.

First Consider: Ownership of Residential Real Estate

You should first look to the title of the property. The method in which title is held may impact the type of planning that can be done with the property.

1. Tenants in Common

Generally, if a deed does not specify how the title to real property is held, then the owners will be deemed to hold the property as tenants in common with equal interests. The default treatment when the type of tenancy is not specified may vary from state to state, especially in community property states. When the title is held as tenants in common, upon the death of a co-owner, the interest will pass under the deceased owner's estate plan or to his or her heirs-at-law. The interest will not pass automatically to the surviving owner or to the surviving owners.

If the deed states that the owners are to be treated as joint tenants, then each owner is treated as owning an undivided interest in the entire property. Joint tenants may have made unequal contributions to the property, but each joint tenant is still treated as owning the entire property.

2. Tenancy by the Entirety

Many states allow spouses to hold title to residential property owned by married couples for their principal residence. Tenancy by the entirety is very similar to joint tenancy in that when one spouse dies the other spouse inherits the entire property. When the title is held in Tenancy by the Entirety ("TBE"), the residence cannot be attached by one spouse's creditor. This differs from joint tenancy, where a creditor of either co-owner can attach the entire property. This makes TBE an attractive method of titling a residence for individuals in higher-risk professions such as physicians.

Some states allow TBE protection to couples who want to hold title to their home in TBE but through their revocable trusts. If TBE is used for trusts, the advisor should clarify with a local title company how the property will pass at death. This is an emerging concept in the law and since the trusts are not individuals, the survivorship concept should be clarified prior to entering into such an arrangement. A couple who has entered into a civil union as well as same sex couples may also be able to hold title to their residence in TBE depending on the how the state of residency regards their marriage.

Option for Postmortem Planning: Disclaimers of Real Estate

A disclaimer can be a useful tool to address a change in circumstances in a decedent's family or to modify an unintended transfer that occurred upon death. Most states allow a recipient of property to disclaim or renounce his or her right to receive property. The recipient of property may use a disclaimer to alter the distribution of property either for tax or non-tax reasons. A disclaimer under state law will require that the disclaimer describe the property or the interest being disclaimed, be signed by the individual making the disclaimer and declare the disclaimer and the extent thereof. If a valid disclaimer is made, the property passes to the next beneficiary or heir as if the individual who disclaimed had predeceased the decedent.

Qualified Personal Residence Trust ("QPRT")

A QPRT can be a tax efficient way to transfer a personal residence out of an estate while avoiding making a large gift. A QPRT is an irrevocable trust that holds a personal residence for a term of years. At the end of the trust term, the residence is distributed to the beneficiaries named in the trust, which is often the owner's children.

A QPRT involves creating a "split interest trust" where the grantor creates a QPRT and retains the right to use and enjoy the property for a term of years and designates beneficiaries who will take the remainder interest. During the term of the QPRT, the grantor has the exclusive right to use, possess and enjoy the residence without payment of rent. The term is selected by the grantor and the attorney drafting the QPRT. Because the gift is calculated by subtracting the present value of the grantor's retained interest, the amount of the taxable gift will be significantly less than the fair market value of the entire property.

One of the sometimes overlooked benefits of a QPRT is that is can be very useful for asset protection planning. Because a QPRT is an irrevocable trust and the residence does not belong to the donor after the transfer, the donor's creditors should not be able to execute a judgment lien against the residence.

The owner of the life interest in a joint purchase will have the right during the owner's lifetime to receive income from the property or to use, enjoy, and possess the property. A term interest gives the purchaser the right to receive income from or to use the property for a specified term. Upon the life holder's death or the expiration of the term, the holder of the remainder interest becomes the owner of the property without a taxable transfer taking place. Any increase in the value of the property is not subject to transfer tax.

Option: Donating Real Estate to Charity

Real estate may also be used to accomplish a family's charitable giving goals. Although gifts of real property to charities are not nearly as common as gifts of cash, if the proposed donation is mutually beneficial, a donation of real estate can make sense. When donating real estate to a charity, the donor must use caution and ensure that the gift is structured in a tax efficient manner.

A donor who holds appreciated property should avoid paying capital gains tax on the property by donating the property. The sale of the property in the charity's hands can generate a large amount of cash for the charity as long as there are no issues or unanticipated costs associated with the property.

Most charities are operating on very limited budgets. Given their limited resources, a charity may not want to own real estate because the property could end up being more trouble than it is worth. Real estate ownership can create additional administrative concerns and expenses for the charity such as insurance, taxes and utilities.

Gifts of real estate (especially where a gift of a commercial property is contemplated) can pose special risks because of potential clean-up liability under the "Superfund" Clean-up Act. For this reason, you may find that before a gift of real estate would be accepted, a charity will require that an environmental audit of the property be performed, likely at the donor's expense.

However, if an individual donates real estate to charity, the charity will likely sell the real estate to raise cash for its charitable purposes unless the charity can use the real estate as its location or for programs.

Conclusion

When planning with real estate that may represent a large portion of the value of your assets, keep in mind that there are many options for planning with real estate.

• Please contact Natalie Perry or another member of Ice Miller's Trust and Estates group with questions regarding options for residential real estate planning. Natalie Perry is a partner in the Trusts and Estates Group, where she concentrates her practice in estate, gift and income tax planning for high net worth families and owners of closely held businesses. Natalie can be reached at natalie.perry@icemiller.com or 630-955-6590.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.