4 Reasons You Need an Estate Plan for Your Home

The time to solve estate planning problems is before they happen. Otherwise, what you think is a loving act—leaving your home to your heirs—can turn into a financial and familial disaster.

A detailed estate plan means your heirs won't face any financial surprises. Image: Siri Stafford/Photodisc/Getty Images

Estate planning is complicated, and you’ll need help from qualified pros, but here are four reasons to start thinking about an estate plan now.

1. A good estate plan keeps your heirs from fighting.

Say you intend to leave your house jointly to a son and daughter. But what if one kid wants to live in the house and the other wants to sell it? A reasonable estate plan wouldn’t force one child to indefinitely forgo a share in the value of the house.

Solutions:

  • If you have other assets, divide your estate, leaving the house to the child who wants it, and property of equivalent value to the other.
  • If the house makes up the bulk of the estate, an insurance professional can help you with a policy that provides enough money for one sibling to buy out the other’s share.
  • In either case, talk with your heirs up front so you structure your estate plan to head off potential problems.

2. A good estate plan means no financial surprises for your heirs.

Two scenarios:

You sold the family home and bought a retirement condo, with a mortgage. Your heirs will eventually inherit both the condo and the loan as part of the estate. But they can’t assume the mortgage unless they’re planning to live in the condo. They’ll have to pay it off. That can be a nasty shock, says A. Raymond Benton, a certified financial planner in Denver. 

It’s possible that in later years you’ll want a reverse mortgage to help pay for nursing care, for example, while you stay in your home. Upon inheriting the house, your heirs will have to come up with the money for the outstanding loan. Otherwise they’ll likely have to sell the house to pay back the lender. The bank won’t allow your heirs to just assume a reverse mortgage.

Action plan: Explain your situation to your heirs in advance as part of your estate plan, so they can be financially and emotionally prepared to accept an encumbered house as part of the estate.

3. A good estate plan means less of an estate tax hit.

With estate planning, your biggest issue is taxation—what else? But you’re pretty safe because although the federal estate tax has returned for 2011 and 2012 (after a 2010 hiatus), it’s toothless for most of us:

  • You won’t get hit unless your estate is $5 million or more. But you’ll pay 35% on inheritances above that. Also, some states have a state estate tax, and those exemptions may be lower.
  • You’ll face little or no capital gains tax. Say your parents bought their house 40 years ago for $20,000; now it’s valued at $250,000. Shortly after you inherit it, you sell it for $250,000. Under 2011’s full step-up rules, you pay no taxes on the profit. (Without any step-up, you would have to pay a hefty tax on the capital gains of $230,000.) Of course, if the home starts to rise in value after you inherit it, you’ll pay capital gains if you sell it later. BUT: only on the difference between its value on the day you inherited it and the price you sell it for.
  • In 2010, there was a limited step-up: Everything you inherited—house, investments, other values—could be stepped up to a total of $1.3 million. So a home sale in 2010 may have given you a capital gains hit, depending on the amount of appreciation of not only the house but other inherited valuables.

I inherited an estate in 2010, so what happens to me?

1. You can apply the 2011 rules retroactively to Jan. 1, 2010. You probably will have to fill out IRS Form 706, which was essentially suspended for 2010 because there was no estate tax.

Or:

2. You can apply the 2010 rules with no estate tax, but only a limited step up—$1.3 million. You may have to fill out IRS Form 8939, which will allow you to calculate basis. The IRS has made a draft form, which, although not final, gives you an idea of the complexities involved in calculating basis in a house.

Which is right for you?

The retroactive $5 million option is a can’t-lose proposition. Only a tiny percentage of estates approach that mark, and you’re sure to avoid capital gains.

If you think your inherited estate may hit $5 million, weigh whether you’re better off paying some estate tax (2011 rules) or no estate tax but possible capital gains taxes (2010 rules). These calculations are complex; consult a tax professional.

Am I free from estate tax forever?

Unfortunately, no. The 2011 estate tax rules aren’t final. If Congress does nothing, in 2013 the exemption plummets to $1 million and you’ll be taxed at a rate of 55% on amounts above $1 million. 

That probably won’t happen—Congress won’t let the exemption fall that low—but, hey, it’s Congress, so you never know.

Various trusts can help with long-term planning, especially if you’re likely to leave a seven-figure estate. There’s no one-size-fits-all solution; consult an estate planning attorney for strategies suited to you.

4. A good estate plan keeps you from losing your house if you get sick.

Of course, you may be thinking, “This is all academic. I’ll have to sell my home to pay for eldercare.” 

But, with a combination of long-term-care policies and trust-based solutions, you can take care of yourself and leave your home to your heirs. Consult a lawyer experienced with estate planning or a qualified financial planner.