Place Property in Trust
If you create a trust for your family, the property owned by the trust will avoid the probate process. Frankly, many of the disadvantages of owning property in joint name are avoided when the property is owned by a trust. If you understand the history of trusts, it will help you understand how a property held in trust will avoid the probate process.
History of Trusts
The basics of trust law have remained unchanged for centuries. Trusts evolved from early English law. In England, no one could own property except for the king. The workers became very dissatisfied with doing all of the work and not owning the land. As the discontent mounted, the king granted the workers use of the land, though the legal title remained with him. Eventually the workers were allowed to hand down the use of the property to their heirs. It became the law in England that the king held legal title of the property for the benefit of the workers, who held equitable title. The separation of legal title from equitable title is the foundation of our trust law.
What are the tax results if you own property in joint name with your spouse at the time of your death?
When you die, your property will be appraised. The appraisal will be divided in half, 50 percent to your estate and 50 percent to your spouse. Because your spouse is considered owner of one-half, that portion will not receive the step-up in cost basis. If he decides to sell the property, a portion of the sales price may include capital gains tax on his 50 percent portion. Your estate's 50 percent portion will be valued as of your date of death; this is called a step-up in basis. Again, see the details on cost basis in Chapter 10 for a better understanding of this result.
A trust is a way for you to name someone who will hold legal title to your property for the benefit of your loved ones. The person who holds the title is known as the trustee, and your loved ones, who will enjoy the use of the property, are known as your beneficiaries.
When you create a trust, you decide what rights your beneficiaries will have. You are known as the settlor or grantor of the trust. In that capacity you will name a trustee. The trustee is like the king. The trustee holds legal title to the property for the benefit of the beneficiaries. The beneficiaries are like the workers. They hold equitable title to the property and enjoy the benefits you gave them in the trust document you created.
As Trustee, You Make All the Decisions
When you die, the trust document you created names a person or an entity to serve as trustee when you are gone. This is technically known as a successor trustee. Also, as creator, or settlor, of the trust, you name the persons who will enjoy the benefits of the property when you are gone. These are known as successor beneficiaries. The trust document you create will provide the successor trustee very detailed instructions on what to do with the property. Those instructions govern who will enjoy your property, when they will enjoy the property, and how they will enjoy the property.
The beauty of a trust is that while you are living you are the creator of the trust and define all of the rights. You can also serve as trustee of the trust, which means you hold legal title. You can also be the beneficiary of the trust while you are living. You truly enjoy all of the benefits of property ownership.
This is why property that is held in trust avoids the probate process. You own the property while you are living, but you own it in your legal capacity as a trustee. When you die, whoever you named as successor trustee automatically becomes the legal owner of the property. The rules about trusts are covered in detail in Chapters 11 through 14. But, for now, just understand why property held in trust avoids the probate process.
The value of receiving a step-up basis in property means that heirs receive property valued as of the date of your death. This step-up basis may reduce or eliminate capital gains tax due if your property has increased in value over the years, and your heirs decide to sell the property.
Don't forget, if you have designated a beneficiary of assets such as IRAs, retirement funds, life insurance, annuities, or pay-on-death accounts, those funds do not go through probate and cannot be changed by a direction in your will. The beneficiary designation form is a contract between you and the issuing company, and that form controls who will receive the funds from those accounts.
There are certain types of property that are not subject to probate because the property is governed by a contractual agreement you entered into while you were living. This type of property will be distributed according to the terms of the contract, and will not be affected by whether or not you have a will.
