Due to provisions that are contained in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 the estate tax exclusion is now $5 million. What this means is that your heirs will owe no estate tax at all if the value of your estate is $5 million or less. Any portion of your estate that exceeds $5 million in total value is subject to a 35% federal levy.
So if your estate is worth less than $5 million you have no reason to concern yourself with the estate tax, right? The answer would be yes… if you intend to pass away either this year or next year. This new tax relief measure that passed through Congress in December is going to expire at the end of 2012. If no legislation is passed in the meantime that alters the estate tax parameters, in 2013 the estate tax exclusion will be reduced to $1 million and the top rate of the tax will be 55%.
This means that if your estate is worth more than $1 million you may indeed want to seek tax efficiency, and one way of doing this is to remove the value of your home from your estate. This can be done through the creation of a qualified personal residence trust. With these trusts you name a beneficiary who will assume ownership of the home after the term of the trust expires. You decide on the term, and you continue to live in the home as usual during that interim rent-free. By doing this you have removed the value of your home from your estate for estate tax purposes.
However, funding the trust with the home is considered to be a taxable gift. But, the actual market value of the home is not used by the IRS to determine its taxable value. The taxable value of the home is reduced by the interest that you retain in the home while you continue to live in it. As a result the taxable value will be much less than the fair market value, and if it falls under the estate tax exclusion the house will change hands at the end of the trust term free of taxation.
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