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Special handling needed to protect the homestead

Family homes, because of their great value and emotional ties, are a challenge in estate planning and require special handling

Family homes, because of their great value and emotional ties, are a challenge in estate planning and require special handling.

Financial advisers should be prepared to help families manage generational transfers wisely to avoid devastating expenses and emotional turmoil.

“In estate planning, the main issue is to help clients articulate their goals for the house,” said Rich Arzaga, founder and chief executive of Cornerstone Wealth Management Inc. “Sometimes it’s the value of the house, but other times, it’s the house itself.”

That is, in some families, it becomes emotional. Sometimes the parents want one of their children to own and live in that house, Mr. Arzaga said.

If that isn’t the case, “let your clients know they have to leave instructions in a will, letting their children know it is expected they will sell it and split the proceeds,” he said.

Unfortunately, poor planning can make such wills moot, stripping the house of its value. Death and taxes are the two great certainties, and in the case of inherited homes, they arrive together.

The estate tax expired Dec. 31, but it comes back next year, with at least a $1 million floor or perhaps a return to the $3.5 million of last year. A nicely appreciated home can put owners over the top, and the heirs may not have the cash for taxes.

STATE TAXES A FACTOR

Even if the estate comes nowhere near the expected $3.5 million federal level, a state estate tax can hit hard. New York’s estate tax kicks in after $1 million, and in New Jersey, the floor is just $675,000.

Typically, clients will get a deduction — not a credit — on their federal returns for their estate tax, so a double hit is possible.

End-of-life costs, such as nursing-home bills, can also force the sale of a house, ending parents’ dreams of leaving it to their children.

Fortunately, many advisers are able to ensure that the family home makes it to the next generation. The key is advanced planning and discussions with the client.

Like many advisers, Caryn B. Keppler, a partner in the law firm Hartman & Craven LLP, recommends a qualified-personal-residence trust as an efficient estate-planning tool.

“It can be a great way to give away a home,” she said.

Such a trust allows the parents to retain rights for a certain amount of time and then pass them on to heirs. It saves on estate and gift taxes by essentially reducing the value of the house for gift tax purposes.

The family sets a term for the trust, based on the parents’ life expectancy and health. They have to survive the term for the technique to be successful. If the term is too short, the retained interest isn’t substantial, and clients don’t get much of a break.

For tax savings, Jeff Duncan, president and founder of Duncan Financial Management Inc., suggests an irrevocable life insurance trust.

For example, consider a house with a $5 million value and an estate tax floor of $3.5 million. That leaves the estate on the hook for $1.5 million at a possible 50% rate.

“You buy a $750,000 policy inside an ILIT — that makes it separate from the estate and available to pay the estate tax,” Mr. Duncan said.

For clients who are concerned about losing a house to nursing-home expenses, Alfred J. LaRosa, a partner in public accounting firm EisnerLubin LLP, recommends a “life estate.”

This gives the owner the right to live in a residence for the rest of his or her life and pass it on to the children. It is especially useful in protecting the house because it keeps it off the table when it comes time to settle medical debts.

IRREVOCABLE TRUSTS

But this isn’t a last-minute technique, Mr. LaRosa said.

“There’s a five-year look-back, so you have to do it in advance, and there could be tax implications. So advisers and their clients should consult with elder-care specialists,” Mr. LaRosa said.

If everyone is amenable, irrevocable trusts are useful in tax planning — but the key word is “amenable,” he said.

The grantor, i.e., the homeowner, may not be emotionally ready to give up control. A trust can do a great job of keeping assets out of the estate, but advisers have to alert their clients to this first.

In fact, if a grantor is a trustee, even in an irrevocable trust, there is a danger that the trust assets will be deemed part of the estate, effectively negating the trust.

The techniques that advisers use will depend on clients’ situations and personalities. But no matter what, the earlier that advisers get started, the more options they and their clients will have.