As any seasoned estate planner knows, it’s crucial to learn of all your client’s assets before developing a comprehensive plan. This is particularly important when it comes to out-of-state real property, which may be subject to that state’s potential inheritance or estate tax if left unaccounted. Add the costs and headaches of an ancillary probate, and your client’s loved ones will be left wishing for a better way. Lucky for you (and them), there is!
Here are five basic planning options to consider for out-of-state real property:
- Selling the property. If the property is held in a state with a decoupled statute, your client could consider selling the property. When contemplating a potential sale, however, be sure to check whether any estate tax advantages would be offset by the capital gains on the sale of appreciated property.
- Gifting the property. Because very few states impose a gift tax, your client could simply gift the property to the intended beneficiary. However, a gift may cause the donee to lose any step-up in basis that he or she would’ve received. Consequently, the donee could incur a significant capital gain tax if he or she then sells the property. When considering a gift, you should also weigh the effect of IRC §2035(b)(3)’s 3-year rule, which requires the inclusion of any gift tax paid during the 3 years before the donor’s death in his or her gross estate.
- Forming a business entity. Another option is forming a business entity (e.g., a limited partnership or limited liability company) and contributing the property to that entity. Your client’s interest in that entity would be intangible property and thus wouldn’t be subject to the estate tax of the state in which the property’s located. Of course, be sure to weigh the costs of establishing and operating the entity against any potential estate tax savings.
- Holding title as joint tenants. If possible, the client could also hold title to the property with the intended beneficiary as joint tenants. This would avoid ancillary probate, as the property would pass to the joint tenant on the client’s death. However, the property would remain subject to any potential state estate tax.
- Transferring the property into a revocable trust. Often the most sensible option, your client could fund the out-of-state property into a revocable living trust. This eliminates the need for an ancillary probate and allows you to specify that California law applies for administration purposes. Putting real property into a revocable trust, however, doesn’t avoid any applicable state estate tax.
For married couples, there are numerous other estate planning techniques that could be used, often involving sophisticated multitrust planning.
As a word of caution, California attorneys generally shouldn’t prepare deeds for out-of-state property, given the differences in other states’ rules and the possibility that doing so would constitute an unauthorized practice of law in that state. It’s best to advise your client to hire an attorney in that state to help with resolving tax issues and to prepare any transfer documents.
For more advanced estate planning tips for out-of-state property, check out CEB’s California Estate Planning, chap 14, and Complete Plans for Small and Mid-Sized Estates, chap 5. To learn more about estate and gift taxes generally, turn to California Estate Planning, chap 10.
Other CEBblog™ posts you may find useful:
- Using Life Estates to Protect Property and Avoid Reassessment
- Tips for Drafting an Understandable Trust
- How to Amend a Trust
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