As an estate planning and tax attorney practicing law in Tennessee, I am routinely asked by many families … Dan, how do we save money on taxes. Unfortunately, this is a loaded question. There are many different types of taxes. There are estate and gift taxes, there are income taxes, there are capital gains taxes, and there are corporate taxes, just to name a few.
For this specific family I was speaking with, they were referring to capital gains taxes on the sale of their home. You see, this family was concerned regarding the tax liability that would be due when they sell their home. This was a home that was bought many, many years ago for $175,000.00, and now it was worth $950,000.00. Even with the $500,000 homestead exemption, this family was facing long term capital gains on $275,000.00 (which could be approximately $41,250 to $55,000 in tax liability).
This family asked … Dan, what can we do to limit or defer our tax liability?
I recommended that an option for them to consider would be a Qualified Personal Residence Trust (or QPRT for short). First, I asked them why they wanted to sell the property? They indicated that they wanted to sell the home and give the proceeds to their children so that they can see their children enjoy their inheritance.
I indicated to this family that this was not a smart decision from a tax perspective. First, if you sell your home for $950,000.00, you will owe capital gains tax on approximately $275,000. This would reduce the amount that you leave to your children from $950,000 to at least $908,750. At this point, I explained that if you gave the balance, the $908,750 to your two children in equal portions, a gift tax return would need to be filed as you have made a taxable gift.
Therefore, I recommended that this family set up a Qualified Personal Residence Trust. I explained that by utilizing this estate planning technique, your home would be removed from your taxable estate when you die. I said, picture $950,000 being deducted from your estate for tax purposes when you both pass away. Next, I explained that the value of the home is frozen at the present $950,000. However, both of you get to continue to live in the home for as long as you like (it can be for the rest of your lives). In addition, your children would be trustees of this trust, and since you want to see your children receive some form of inheritance and see them enjoy it, you could pay them the fair market value of the property each month or annually for the rest of your lives. I explained, that this would continue to reduce your taxable estate, allow you to see your children enjoy their inheritance, and let them have the home now while you continue to live in the home.
Finally, I explained that this strategy would also allow your children to save considerable capital gains tax liability they finally sell the home when both of you pass away.
Seeing the benefit in this type of planning, this family got started with this legal strategy to reduce their tax burden.
If you have questions regarding family wealth transfer planning and estate planning, and what you can do to limit your tax liability, I encourage you to contact our office at (615) 472-2482 and speak with one of our attorneys.
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