Living Trusts eXplained, and why you should have one
About 20% of Americans now have Living Trusts as part of their estate plans. One thing I’ve noticed from doing many title searches over the years is that the higher-priced the neighborhood, the higher the percentage of homes titled in Living Trusts. What is it that the wealthy, and their expensive financial advisors, have discovered about Living Trusts? You may already know that having a Living Trust will keep your heirs from having to go through the miserable and expensive experience of a probate court case if you own real property. But trusts have many benefits to you, while you’re alive and kicking. Let’s find out why having a living trust, and holding your real estate in a living trust, is such a wise strategy. In this article, we’ll learn about trusts in general, revocable vs irrevocable trusts, Living Trusts in particular, and show you seven ways having an estate plan featuring the Living Trust can benefit you and your family.
WHO should have a Living Trust
I firmly believe from the bottom of my heart that every adult who owns at least one improved property should have a Living Trust. Why? I’ve personally had to go through probate, as an attorney, and as a beneficiary, and it is a full-blown court proceeding that can take well over a year with a number of court hearings and a huge hassle for the executor, and where tens of thousands of dollars from the estate will be given to the probate attorney. So let’s get more specific about who needs a Living Trust the most.
If you live in California and check off one or more of the following,
then you should have a Living Trust:
- You own real estate anywhere in the USA worth over $184,500 (as of 2023)
- You have heirs (children, grandchildren, or other family members or close friends)
- Bonus points if you are single (you have no spouse to automatically inherit)
- More bonus points if you own real estate in multiple states (your heirs would need to open a separate probate case in each state)
What is a TRUST?
People ask me all the time, what is a trust? I could give you a legal definition , but I like to compare it to something most people already know about, a corporation. Trust documents are like corporate documents, in that they are legal entities created by contract law that have certain elements. The “Grantor” of the trust is like the founder of the company. The “Trustee” is like the CEO or President of a corporation, the person who runs the show. The “Beneficiaries” of the trust are like the stockholders or shareholders of the corporation, and as the name implies are the ones who benefit or stand to benefit from the operation of the trust.
So, what exactly is a LIVING TRUST?
A “Living Trust” is a type of trust that is designed primarily as a powerful estate planning tool. This Revocable Trust is a legal arrangement through which you can distribute your personal and real property after you die. Unlike a Will, which only becomes effective upon your death, a Living Trust is established during your lifetime, so it not only determines how your assets are distributed after you pass away, but also has a number of benefits for you while you are alive & kicking. That’s the “living” part. As the Grantor, you establish the trust and transfer your property and assets into it. You choose the beneficiaries who will eventually receive the trust’s assets in whatever manner you see fit. You also appoint a Trustee to manage the trust, and one or more Successor Trustees who become the new “CEO” after you pass. You, the Grantor, determine the powers of the Trustee. Some people just say “whatever the Trustee decides to do” which is called a Discretionary Trust, while others spell out what happens to every single piece of property in the state in great detail. It can get as complicated as you like, and an estate plan can also appoint guardians for minor children and provide for kids and adults with special needs. Now the interesting and unique thing about the Living Trust is that you – and your spouse or partner if you choose to do it jointly – are the Grantor, The Trustee and (while you’re alive) the Beneficiary. Speaking of “jointly”, the most common Living Trust is with a couple (typically married), and the two partners are the Co-Grantors and Co-Trustees. The trust is still “living” until the second spouse/partner passes away. Once the last Grantor passes away, the trust instantly becomes Irrevocable, and the first Successor Trustee now becomes the Trustee, and is legally obligated to follow the instructions that you made in the estate planning documents. As I mentioned a moment ago, some people give this new Trustee very specific and detailed instructions, while others give the acting Trustee full discretion to use their best judgment. And if you have minor children when you pass, a Guardian that you nominated in your estate plan now becomes the new “parent” of the children, thus avoiding any potential family disagreements.
Revocable vs. Irrevocable Trusts
You may have heard that there are two main types of trusts; Revocable Trusts (Grantor Trusts) and Irrevocable Trusts. While only two letters are different in their spelling, they are completely different legal entities. The “Living Trust” we’re talking about here is a REVOCABLE TRUST, which is much more common than the Irrevocable variety. Although the legal term is “Revocable Trust”, it really should be called “Amendable Trust” as people rarely revoke them, but often make amendments (changes) to them over time. The IRS calls it a “Grantor Trust” because you, the Grantor, have full control over it. You can easily transfer assets to and from the Revocable Trust, amend it, or even terminate (or “revoke”) the trust.
On the other hand, the whole point of having an IRREVOCABLE TRUST is that you have NO control over it, and in fact, the assets that you place into an Irrevocable Trust are no longer legally owned by you; they are controlled by the Trustee, who is somebody other than yourself. In my opinion, Irrevocable Trusts should rarely be used, as “Irrevocable” means “forever”, and once they’re created you can’t change your mind. They are commonly used for elderly wealthy people to get out of the federal estate tax, which doesn’t apply to anybody with less than an estate worth $12.92 million in 2023; only 0.04%$ of estates paid that tax since it was raised by the Tax Cuts and Jobs Act of 2018. By the way, in 2026, the estate tax might kick in at a lower amount if the bill is not renewed. The other main group who use Revocable Trusts are those interested in true Asset Protection; in other words, people who are expecting to be sued, or perhaps contemplating a nasty divorce. The property in an Irrevocable Trust is safe from creditors because as I stated above, you legally don’t own it anymore. Note: Revocable Living Trust distributions are typically NOT TAXABLE as they are considered “gifts” and not income, but Irrevocable trust distributions could well be subject to taxation depending on who receives them and how much they receive. Anyone considering an Irrevocable Trust should talk to their CPA, financial advisor and probably a business attorney as well.
Now if Asset Protection is your primary concern, there are other less drastic ways to shield your property from potential creditors, such as Land Trusts. You would have each property in its own Land Trust, and like an Irrevocable Trust, the Trustee of the Land Trust is a third party. However, that’s where the similarities end, as (1) the Land Trust is Revocable (and amendable), and (2) the Trustee is obligated to follow your directions and instructions. If you’re interested, I’ll be talking about Land Trusts in another blog here at Rock Real Estate.
Ten Benefits of Living Trusts
Now that we understand what a Living Trust is, let’s explore the benefits that make it such an attractive option for many individuals and families. By understanding these advantages, you can make an informed decision about whether a Living Trust aligns with your needs and goals.
Benefit 1: Avoiding Probate
One of the biggest advantages of a Living Trust is that it allows your heirs to avoid the time-consuming and expensive Probate process. When you title your assets in the name of the trust, they are no longer considered part of your probate estate. This means that your beneficiaries can receive these assets more quickly after you pass away, without the need for court intervention. Don’t forget, a Will should be called a “Will Not” because a Will alone WILL NOT keep your heirs from having to suffer through the probate process if you own property. What is the “magic” that allows this to happen? Well, if your property is owned by “The Smart Family Living Trust” while you’re alive, who owns it after you die? That’s right, “The Smart Family Living Trust” still owns the property, so there wasn’t a “transfer” of title, as the only change is the Trustee. And from almost any standpoint, especially regarding taxes, a transfer of property is not a good thing. Avoiding Probate is an even bigger deal if you own property in multiple states. Did you know that if you passed away without proper estate planning a separate court case would need to be opened in every state where you own real estate? If you are a buy & hold investor with properties around the country, that means your heirs would have to file multiple cases and hire attorneys in multiple states.
Benefit 2: Maintaining Control and Flexibility
With a Living Trust, you retain maximum control and flexibility over your assets. You can make changes to the trust throughout your life to accommodate new plans or beneficiaries. This document allows you to ensure that your intentions with estate planning are plainly evident, making it very challenging for disgruntled family members to contest the trust. (We put in a “No-Contest Clause” to strongly discourage that.) And remember, if your heirs have to open a Probate case, you don’t decide what happens to your property, a judge does.
Benefit 3: Customized Asset Distribution
A Living Trust allows you to determine precisely how your assets are distributed. Truly what the Trust can do is only limited by your imagination… as long as it’s legal. Whether you want your beneficiary or beneficiaries to receive a certain amount of income per month or have specific conditions for asset distribution – such as graduating from college – a Living Trust ensures that your intentions are met. You can decide what percentages or what property each beneficiary receives, and how things are distributed if one or more of them pass away before you do. ALL possibilities are considered in a good estate plan.
Benefit 4: Privacy and Confidentiality
Privacy is a crucial aspect of estate planning for many individuals. While a Will becomes part of the public record when the probate case opens, a Living Trust remains a private document. The trust’s details, including the identity of the beneficiaries and the distribution of assets, are not accessible to the public. This privacy allows you to maintain confidentiality within your family and ensures that your plans are not open to scrutiny or potential challenges. You instruct your Successor Trustee what to do, and he handles it as a private matter.
Benefit 5: Tax Benefits
Heirs don’t pay taxes on Living Trust distributions in California. I have counseled many people who wanted to put one or more family members on Title while they were alive. I always have to remind them that the state and federal laws are favorable to property transfers at death, and penalize those who make “inter vivos” transfers, even to their kids. Always keep in mind this general rule: “Inheriting is good.”
(a) CAPITAL GAINS TAX (Federal and State)
Beneficiaries save big on federal (and state) Capital Gains Tax if they inherit the property. But what if you want to transfer title to your home to your beneficiary NOW (during your lifetime)? If you put them on Title now, you transfer your current tax basis to them which is the price you purchased the property for. So they would have to pay tax on the difference between what you paid for the property, and what it’s worth whenever they sell it, which could be a huge amount if you owned the property a long time. They could pay a massive tax even if they sold it immediately after you gave it to them. On the other hand, if you place your property in your Living Trust and have them receive the property when you pass away, then your heir(s) will get a new tax basis to the current market value at the time of your passing. If they sold it the, they’d pay no capital gains tax at all. Eventually, when they sell it, the capital gains tax would be much lower because the starting point will be the fair market value when they inherited it, not the price you purchased it for years ago. Also, you won’t have to worry if they get into an accident, file for bankruptcy, or have an IRS audit, since they won’t yet be on Title to your property.
(b) PROPERTY TAX (State/County)
Your heirs also would save big on Property Tax Reassessment, especially for California properties. If you transfer your property while you’re alive, in many cases the property will be reassessed to its current fair market value. Thanks to California’s unique property tax scheme (due to Proposition 13), your property tax bill could increase drastically if you’ve owned the house for a long time. Remember, Proposition 13 drastically limited the amount that your property taxes can rise each year, so if you’ve owned the property a long time, you are paying much less property tax than you would in any other state. Post Proposition 19, children and grandchildren can avoid this reassessment, but only if they live, and continue to live, in the property as their primary residence. Otherwise, the person you are making an inter-vivos gift to would be saddled with a much larger property tax bill than you are paying.
Benefit 6: Financial Protection for Your Heirs
Living Trusts also have a special benefit to the heirs of a Californian’s estate. Did you know that if you end up having major medical bills at the end of your life – as many people do who have long treatments for cancer and other terminal diseases – that your medical bills can be “recovered” from your estate when you pass away? In other words, if you leave your loved ones a $1M house free and clear and you have $1M in medical bills, your heirs would be forced to sell the house and your loved ones would get nothing! That’s a BIG deal. Under State Law (and this is true in most states), Medicare (and Medicaid/Medi-Cal or whatever it’s called in your state) bills must be paid from the estate. As the California HCS website states, “The Medi-Cal program must seek repayment from the estates of certain deceased Medi-Cal beneficiaries. Repayment only applies to benefits received by these beneficiaries on or after their 55th birthday and who own assets at the time of death. When you receive our claim amount and are ready to submit payment, we accept Electronic Fund Transfers (EFT) and checks.” That is a message that nobody wants to receive! But wait, there’s more. And it’s good news to Californians. “For Medi-Cal members who died on or after January 1, 2017 ( due to SB 833), repayment will be limited only to estate assets subject to probate that were owned by the deceased beneficiary at the time of death.” So if you have a Living Trust, your heirs are not subject to probate, and they are not subject to paying for your unpaid medical expenses.
Benefit 7: Cost Savings for California Investors
As I mentioned earlier, many California Real Estate Investors have LLCs or some form of Corporation. Many National Real Estate Investing “gurus” advise Buy & Hold Investors to form a separate LLC for every property, which does afford some asset protection. But did you know that even if your California Business entity has $0.00 in transactions for the year that the tax bill for that entity is still $800.00? OK, so maybe you knew that. So you just go ahead and open (a) Nevada or Wyoming LLC to avoid that. Well guess what? If the California Franchise Tax Board determines that you are a California Resident, then they will bill you $800 per entity no matter where your LLCs or your properties are located. If you have five LLCs, that’s a $4,000 state tax bill for starters, yikes! Compare that to a Living Trust (or Land Trust), which costs you nothing. So putting your properties in your Living Trust can save you real money every year if you haven’t got around to forming an LLC or two.
Benefit 8: Business Advantages
But what if you already have an LLC? Well, you can assign it to your Living Trust, which won’t save you the $800, but would give you some added asset protection and keep the business moving when you pass away. When a partner in your business passes away or becomes disabled, a revocable living trust can be an important tool in addressing concerns about succession of leadership and ownership. Companies can find themselves in critical financial distress, or out of business altogether, due to estate taxes or other related hardships that result from the death of an owner or key partner. A trust of this kind can appoint a successor trustee and instruct them to continue business operations. However, there are some complications to consider. A business owner cannot be both the sole beneficiary and trustee of the trust holding their business, which means they would need to involve family members, spouses, or a third party as beneficiaries or trustees. This can raise concerns in the case of divorce or add costs for hiring a third-party trustee. (On the other hand, there are no issues if you are the typical Living Trust client who has family or friend beneficiaries and if married a co-trustee.) You might want to consult with an experienced business attorney and/or business CPA to determine if having your trust “own” your business entity is the right setup for you.
Benefit 9: Children from Prior Marriages
In the modern world, people live longer lives and have more marriages than in previous generations. This makes it increasingly likely for legal disputes over assets to occur between spouses and children from different chapters of a family’s history. A second spouse may want to shut out biological children from a first marriage. A revocable living trust can spell out the boundaries within which the surviving spouse must act, limit their control of the trust, prevent them from disinheriting children of entities that the first marriage, and move certain assets into a separate trust solely controlled by the biological parent.
Benefit 10: Personal or Beneficiary Disabilities
A revocable living trust is an ideal way to keep assets under your control even if you become mentally or physically unable to manage it. In addition, it can protect the trust’s beneficiaries with disabilities from losing Supplemental Security Income (SSI) benefits. Under current federal rules, SSI recipients can be disqualified from receiving benefits if they come into an inheritance. Even if they disclaim the inheritance, they may still be hit with a significant penalty, depending on the value of their share. A carefully crafted document can avoid this issue with the inclusion of a special needs trust, which allows the individual with special needs to receive the inheritance in a separate account earmarked for “non-Medicaid” use. They will then continue to collect SSI benefits in support of their disability. The Living Trust can also address future plans for disabled adults living in the home, should the grantor pass away, typically with a provision that provides a “lifetime interest” in estate assets for those individuals.
Conclusion
Determining whether a Living Trust is right for you is a personal decision based on your unique circumstances and goals. However, the benefits of a Living Trust, such as avoiding probate, maintaining control and flexibility, customizing asset distribution, preserving privacy, gaining tax advantages, and saving money, make it an appealing option for many. If you’re considering setting up a Living Trust, we highly recommend consulting with an experienced estate planning attorney, especially one knowledgeable in California laws. They can guide you through the process, ensure all your legal documents are in order, and help you create a comprehensive estate plan. I happen to know a great Estate Planning Attorney… that would be me! For more info or if you have questions, call me at 833-9-SIMONE or schedule a Free Consultation right now. The Simone Legal Comprehensive Living Trust Package features a twenty-page Living Trust, and also includes a Certificate Of Trust, Pour-Over Will, Durable Power of Attorney, HIPAA Waiver, Advanced Health Care Directive, Final Arrangements section, and the Deeds you will need to fund the trust. It offers numerous benefits during one’s lifetime, such as enabling the people you choose to make medical and financial decisions and giving them access to your medical records if you ever became legally incapacitated. And of course, it ensures a smooth transition after passing, preventing family disputes and providing guidance on funeral arrangements and asset distribution.
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