Should Real Estate be in a Trust? Revocable, Irrevocable, LLC -

Should real estate be in a trust? Yes, to protect it against probate unless it generates liabilities. Then, you should form a limited liability company (LLC) to protect it from creditors. In general, you should:

Put your primary residence in a revocable or domestic asset protection structure
Place your investment properties in LLCs to protect yourself from creditors

Which structure is best for you depends on your situation and property type. These decisions depend on complicated details about your assets. You should sit down with a good estate planner and attorney to discuss your specific situation.

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Home in a Revocable Trust

You should put your house in a trust if you want to avoid probate. You can modify, dissolve, or rescind a revocable type, and it saves your beneficiaries the lengthy process and cost of probate. It creates issues with the ownership of your property, however.

Purchase – You must purchase the house in your name and then transfer it

Sell – You must remove the property and then sell it in your name
Taxes – The trust won’t impact a home residence home sale exclusion or mortgage interest deduction, but it may trigger a reassessment of property taxes depending on where you live
Insurance – The transfer may impact your title and homeowner’s insurance

You should talk to your attorney about how each of these impacts your plans before you create it. While it makes the transfer process much easier for your loved ones it might generate some headaches for you if you want to refinance your home.¹

Quitclaim Deed Vs. Living Trust

In estate planning, you are usually not better off using a quitclaim deed vs living trust. Most people consider cost basis and Medicaid planning when they decide to use a quitclaim deed.

Cost basis – The price you paid for a property as opposed to the fair market value of the house

Medicaid planning – Remove assets in order to qualify for Medicaid

Cost basis is a big problem if you use it instead of a will. When you use a will, your loved ones receive the property on the cost bases, which is usually much lower. When you leave it through a quitclaim deed, they receive the property at fair market value. That means they pay much more taxes.

Medicaid has a five-year lookback period. This means they look back to see if you transferred any property and include it in their qualification assessment. Therefore, this strategy may be tricky, and you really do need an experienced attorney to help you plan.²

Transfer With Mortgage

Should real estate be in a trust if it has a mortgage? You can transfer property with a mortgage. Many people falsely assume it isn’t possible, or it’s very hard because of a change in ownership. The mortgage industry makes an exception for this situation because you aren’t really changing ownership. For a revocable structure:

The homeowner grants the property to the trustee in trust.
The trustee is the grantor until that person dies.

Then, a new trustee takes over management. The grantor dictates all of this in the entity’s documentation when he/she first sets it up.

As you can see, until death, the owner really doesn’t change, but how the property is kept does. You still pay taxes and loans the same way, so the mortgage company accepts the new arrangement.

However, if you refinance many lenders make you take the house out before they will give you a new loan. The Federal National Mortgage Association is changing its guidelines for refinancing, too. New policies make it easier for you to refinance without taking your home out. Check with your lender to see what their policies are regarding refinances.³

Should Real Estate Be in a Trust or LLC?

Whether a trust or LLC is better depends on your situation and the type of property you own. Which is better depends on liability issues with the property. You should put:

Your primary residence, land and second/vacation homes in a trust
Rental and other investment properties in an LLC

LLCs limit liability and protect you from creditors. Living trusts protect your estate from going through probate courts. Unless you rent a room or portion of your house that creates a liability you should never consider putting your home in an LLC. On the other hand, an investment property that generates income has substantial liability issues.

Another thing to consider is how much equity your home or vacation property has. If you have paid off your mortgage or have a lot of equity you might consider a domestic asset protection trust. This protects your property from personal liabilities.⁴

Rental Property

You should hold rental property in an LLC. Rental properties generate both income and liabilities. If you own the property:

Personally – Creditors can go after you all your personal assets, income, and wages
In a trust – Creditors can go after all the assets held in the entity
In an LLC – Creditors must sue the entity and can’t go after the owner personally

You should consider putting any property you have that generates income and liabilities into an LLC. This includes your primary residence and second homes and vacation properties. While most of the time these should be in a living trust, liability is the key. Does your property generate liabilities? If it does you need to talk to your attorney about the best way to protect your assets.

Capital Gains

Most people don’t have to worry about this on their primary residence because exclusions are $250,000 for single and $500,000 for joint filers. Most people never reach those thresholds when selling their homes, but trusts have much lower thresholds. Therefore, it’s important for you to think about how you structure your trust.

Revocable – For tax purposes assets belong to the grantor (you). As a result, you meet the capital gains exclusion.

Irrevocable – You cannot claim the exclusion on capital gains. The proceeds from the sale stay within the trust, and it owed the capital gains on the profit.

There is one other thing to think about, though. Revocable become irrevocable upon the death of the grantor. At this point, the property gets a step-up in tax basis. What this means is you won’t have to pay capital gains taxes if you sell the house immediately.⁵

Final Thoughts on Should Real Estate be in a Trust

Whether your property should be in trust depends on liability. Ask yourself, does the property generates income and liabilities? If the answer is yes, then you should form an LLC. If it does not, then you should put it in a trust. For tax, liability, and estate planning issues you should not hold your properties directly under your name.

All of this gets complicated quickly. The more complicated your assets the more you need a good estate planner and attorney. We highly recommend that you find a local professional that understands the laws in your area to help you set up a proper plan.