It is a good feeling to watch your home go up in value, and in some areas, the prices have dramatically increased over the last decade. This is a great development for homeowners and savvy investors, but it can lead to estate tax liability.
Federal Estate Tax
Your real property is part of your estate for tax purposes, so property value increases can be a factor on this level. We use the term “can be” because the relevance will depend on the overall value of your estate.
There is an estate tax exclusion that can be used to transfer a certain amount before the tax would potentially be levied on the remaining portion.
A $5 million exclusion was established in 2011 when a piece of tax legislation was passed, and this figure was retained indexed for inflation through 2017. During that year, the exact amount of the estate tax exclusion was $5.49 million.
The Tax Cuts and Jobs Act was enacted at the end of 2017. One of its provisions doubled the exclusion, and an inflation adjustment was added. This resulted in an $11.18 million exclusion in 2018. After a series of adjustments, the exclusion is $13.61 million this year.
Married Couples
There are a couple of details that apply to married couples. Spouses can transfer unlimited assets between one another free of the estate tax, as long as they are American citizens.
A surviving spouse can use the unused portion of their deceased spouse’s exclusion. This arrangement is called “portability” in tax and estate planning parlance.
Gift Tax
Lifetime gift-giving is not a cure-all option as an estate tax efficiency strategy, because there has been a gift tax in place continuously since 1932. The two taxes are unified, so the exclusion is a unified exclusion that applies to your estate and lifetime gifts.
However, there is a separate gift tax exclusion that allows you to transfer up to $18,000 each year to an unlimited number of gift recipients. You can also pay school tuition for others tax-free, and there is an exclusion that allows you to pay medical bills for other people in a tax-free manner.
Estate Tax Exposure
Significant increases in real property values could push your estate into taxable territory, and there are some additional considerations. The provision in the Tax Cuts and Jobs Act that established the record-high exclusion is going to expire at the end of 2025.
In 2026, the exclusion is going back to $5.49 million indexed for inflation unless changes are implemented in the meantime via legislative mandate.
One of our offices is in Westport, Connecticut. According to Realtor.com, the median listing price for a home in Westport at the time of this writing is $2.6 million. Many people in this area have to be quite concerned about the coming estate tax exclusion reduction.
State-Level Estate Tax
Here in Connecticut, we have a state-level estate tax to contend with as well. The exclusion is now equal to the federal exclusion, so it stands at $13.61 million this year. In addition, there is a gift tax on the state level, so this is another consideration.
Estate Tax Efficiency Strategies
There are steps that you can take to mitigate your exposure to estate taxes. Irrevocable trusts will typically be part of the plan. Since we are on the subject of home ownership, we should take a look at the qualified personal residence trust.
To implement this strategy, you convey your home to the trust, and you name a trustee and a beneficiary. When the trust is being set up, you establish an interim during which you will remain in the home as usual. This is referred to as the “retained interest period.”
When you go this route, your home is no longer part of your estate, but you are giving a taxable gift to the beneficiary. However, the IRS will determine the taxable value taking the current value (not the anticipated future value) and the retained interest period into account.
The value of the gift is reduced because you will be living in the home for several years before it is transferred. Ultimately, the taxable value of the home will be considerably less than the actual value when it becomes the property of the beneficiary.
We Are Here to Help!
If you are ready to put a plan in place, you can schedule a consultation at our Glastonbury or Westport, CT estate planning offices if you call us at 860-548-1000. There is also a contact form on this site you can use to send us a message, and if you reach out in this manner, you will receive a prompt response.
Mr. Nirenstein is licensed to practice before the courts of the State of Connecticut and the United States District Court. He is a member of the Connecticut and Hartford County Bar Associations, and the Estate and Probate, Elder Law, Business Law and Real Estate Sections of the Connecticut Bar Association.