Primary Residence in a Trust – Tax Planning

Trusts are a standard tool people use in their estate planning. They allow you to plan for what will happen to your property, savings, and investments after your death. Putting your primary residence in a trust can be a straightforward way to pass on your home to your heirs without the headache of going through probate. But what are the tax implications of putting your primary residence in a trust? 

You may have heard that certain types of trusts provide you with certain benefits, but it’s essential to know what these benefits are when handling your tax planning and deciding whether to place your home into a trust. Explore our guide to property trusts to help you decide whether putting your home into one is the right choice for you.

Key Takeaways

• A property trust is a financial and legal situation where a trustee holds someone’s property on behalf of an eventual heir.
• Revocable trusts allow you to revise the trust and retain ownership of your property, but they don’t have tax benefits.
• Irrevocable trusts revoke your ownership of any property in the trust, but they can provide some benefits on estate taxes.
• Estate tax only applies to people with high-value estates, so trusts aren’t a regular part of the tax planning process. 
• Many people set up trusts to assist with estate planning and preserve their privacy instead of getting tax breaks.

What Is a Property Trust?

A property trust is a financial agreement where a neutral third party oversees property assets that an individual wants to pass on to another person. You should understand a few basic terms when discussing property trusts:

• Beneficiary: A beneficiary is a person who eventually receives the assets in a trust. A trust can have a single beneficiary or multiple beneficiaries.
• Grantor: This individual currently owns the property.
• Trustee: The third party managing the trust is known as a trustee. A trustee can be an individual or an institution, such as a trust company. You can also appoint yourself as your trustee.

The trustee holds the legal title of the property on behalf of the beneficiary and manages it based on the grantor’s wishes. To put your property into a trust, you work with a lawyer to create a document detailing the trust’s terms and structure. Two main types of property trusts exist, each with different functions:

What Is a Revocable Trust?

Also known as a living trust, a revocable trust is a flexible document that the grantor can modify, update, or remove at any point. The grantor has open access to the assets in a living trust, meaning the individual can spend money from accounts in the trust or sell property included in the trust. This type of trust has no tax benefits for the grantor.

Typically, people create living trusts to plan for the event of their death or possible incapacitation. When you put assets in a trust, the beneficiary automatically becomes the owner of these assets upon the grantor’s death. People may put their homes and other assets into a living trust to keep them out of probate, allowing their heirs to save money and time on legal proceedings. It also ensures that the grantor’s heirs can make decisions about the estate if the grantor can no longer make these choices.

What Is an Irrevocable Trust?

As the name implies, you can’t modify an irrevocable trust. Once you place your assets into a trust, you no longer legally own the assets. The trustee has full authority over the trust until the assets pass to the beneficiary. Irrevocable trusts protect your assets so that creditors can’t target funds you place into a trust. If you want to ensure that your home won’t be vulnerable to creditors in the future and you’re comfortable giving up legal ownership of the property, transferring a house into a trust is an option to consider.

Because you forfeit ownership of the assets you place into a trust, this decision does come with tax benefits. If you place your primary residence into an irrevocable trust, it typically no longer incurs estate taxes. Putting your home into an irrevocable trust may also decrease the size of your estate to below the federal threshold for estate taxes, meaning you wouldn’t have to pay any estate tax at all.

Can I Save Money on Taxes With My Primary Residence in a Trust?

For most people, putting their primary residences into a trust won’t help them save money on their taxes. A revocable trust, the most common type, has no tax benefits for the grantor. 

Although irrevocable trusts can help you save money on estate taxes, this savings only applies to people who have a high-value estate. The federal estate tax threshold is $12.92 million for a single person. If your estate is worth less than this figure, you won’t receive any financial benefits for putting your home in a trust.

However, consider putting your residence into an irrevocable trust if you have a high-value estate. Think about a situation where you’re single with a $15 million estate, including a home worth $3 million. If you place the house into an irrevocable estate, that amount no longer qualifies for estate tax. With a remaining estate value of $12 million, you narrowly avoid paying any estate taxes.

Even if your estate is worth much more than the threshold, placing your home into the trust would still reduce your taxable estate by the home’s value.

Tax Benefits for Beneficiaries

The one tax benefit you can get from a standard revocable trust applies to the beneficiary, not the grantor. The Section 121 exclusion allows people to take an exclusion on capital gains from selling their primary residence. It excludes up to $250,000 for individuals and $500,000 for couples. Section 121 (d)(9)(C) stipulates that the exclusion also applies if a trust sells a property where the grantor or the heir uses the home as the primary residence. 

Establishing a primary residence involves living in a home for two out of the five years before its sale. If a grantor lived in a house for two years out of the five years before the individual’s death, an heir could sell the home and take advantage of the Section 121 tax exclusion. You can also combine occupancy periods from the grantor and the beneficiary to meet the residency requirement. For example, if you lived in a home for one year of the five years, and your heir moves in for a year, your heir can receive the exemption.

Setting Up Your Trust

Even though the tax benefits of putting your home in a trust are limited, you still have plenty of reasons to consider a trust as part of your estate planning. If you’re a private person, placing your home into a trust can keep your name out of public records. When you designate a third party as the trustee of your home, the name of the trust goes on public documents instead of your name. You can privately transfer properties in and out of the estate with an irrevocable trust.

A trust can also provide peace of mind, reassuring you that your beneficiaries will gain ownership of their inheritance. And while someone can challenge a trust in court, it’s much more difficult to contest a trust than a will. For revocable trusts especially, the ongoing involvement of the grantor provides hard evidence of the assets’ intended distribution.

Consulting with a professional can give you insight into your unique situation if you’re curious whether setting up a trust is right for you and your estate. Our team at Anderson Advisors can review details such as asset protection, the probate process, and potential tax implications for your estate. Schedule an estate planning consultation today.