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Tax Implications of Transferring Real Estate to a Living Trust

Transferring real estate to a living trust is a common estate planning strategy that can offer numerous benefits, including avoiding probate, ensuring privacy, and providing for seamless management of assets in case of incapacity. However, it’s essential to understand the tax implications of such a transfer to make informed decisions and avoid unexpected consequences.

What is a Living Trust?

A living trust is a legal entity created during an individual’s lifetime to hold and manage assets. The person who creates the trust (the grantor) can also serve as the trustee, maintaining control over the assets, including real estate, during their lifetime. Upon the grantor’s death, the assets are transferred to the designated beneficiaries according to the terms of the trust, bypassing the probate process.

Tax Implications of Transferring Real Estate to a Living Trust

Income Tax

Transferring real estate to a living trust typically does not trigger any immediate income tax consequences. The Internal Revenue Service (IRS) considers this a non-taxable event because the grantor, as the trustee, retains control over the assets. Therefore, the property’s transfer does not constitute a sale or disposition that would generate taxable income.

Property Tax

In most cases, transferring real estate to a living trust does not affect property taxes. The trust is usually considered a “pass-through” entity for property tax purposes, meaning the property is still treated as owned by the grantor for tax purposes. However, it’s essential to check with local tax authorities, as rules can vary by jurisdiction.

Capital Gains Tax

When real estate held in a living trust is sold, capital gains tax may be applicable. However, the tax treatment is generally the same as if the grantor owned the property outright. If the property was the grantor’s primary residence, they might be eligible for the capital gains tax exclusion (up to $250,000 for single filers and $500,000 for married couples filing jointly), provided they meet the IRS’s ownership and use criteria.

Estate Tax

Living trusts can also have implications for estate taxes. While transferring property to a living trust does not reduce the estate’s value for estate tax purposes, the trust can be structured in a way that helps minimize estate taxes for larger estates. It’s crucial to work with an estate planning attorney to ensure the trust is set up to achieve these tax-saving objectives.

Step-Up in Basis

One significant tax advantage of holding real estate in a living trust is the step-up in basis that occurs upon the grantor’s death. When the property is transferred to the beneficiaries, its tax basis is “stepped up” to the fair market value at the time of the grantor’s death. This can reduce potential capital gains tax liability if the property is sold by the beneficiaries.

Understanding the benefits

Transferring real estate to a living trust can be a wise estate planning move with several tax advantages. However, it’s essential to understand the tax implications and work with professionals to ensure that the transfer aligns with your overall financial and estate planning goals. By doing so, you can maximize the benefits of your living trust and provide a smooth transition of assets to your beneficiaries.

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What is a Trust?

A Living Trust is a financial tool that lets you plan, organize, and protect your life. It’s a personal entity that allows you to add assets and plan out your inheritance. Eliminating legal battles, cost, and time spent by your loved ones. 

Think of it like a personal LLC that you put everything you own in. Except it doesn’t protect you from liability like an LLC does, it protects you from probate and conservatorship. 

Probate is the complicated court process (12-18 months) where a judge decides what happens to your assets after you die, become incapacitated, or are “deemed” incapable. Creating a living trust allows your assets to completely circumvent probate and immediately transfer to your loved ones. 

In addition to being able to name heirs (your beneficiaries), a Trust also allows you to assign someone to manage it (your successor trustee). Instead of going through probate, your Successor Trustee takes control of the Trust, handles your affairs, and distributes your assets according to your instructions. The person you select as Successor Trustee should be your most trusted person. Like a best friend or closest family member.

At Dynasty, we believe everyone should have a Living Trust. If you have children, assets, or plan to acquire assets in the future, you should create a Trust. That way when you buy your next home, open a bank or brokerage account, get startup shares, etc. – you can immediately title them in your trust.