If You Own Property in More Than One State, You Need a Trust
In the world of personal finance, rarely is it possible to find advice that is straightforward and offers a definitive yes or no answer. In this case, however, both apply almost uniformly. Any person who owns real, fixed assets (houses, land, buildings, etc.) in multiple states can save their loved ones months of extra paperwork and unnecessary fees by utilizing a living trust to execute their estate plan.
Owning real estate in more than one state requires special considerations when it comes to estate planning. While it is certainly possible to have more than one residence, it is not possible to have more than one domicile. For estate planning purposes, a person’s domicile is the state in which they maintain a permanent home. Their domicile is also used to determine important factors like where they can vote, file taxes, and claim retirement, healthcare, and unemployment benefits.
Additionally, the state where a person is domiciled is where any estate taxes are paid and where the estate goes through probate upon the owner’s death. However, having a domicile in one state does not automatically prevent property in another state from also being taxed. The state where you are domiciled can have a significant impact on your overall tax bill. Even if exempt from federal estate tax, your estate may still be subject to a state's tax. And if your residency is unclear at the time of death, two states could claim that you resided within their borders and tax your estate accordingly.
When a person dies, any assets in their name must pass through a process called probate. Probate is a formal judicial process whereby a will is proved in a court of law and accepted as a valid and true last testament of the decedent. Probate courts exist to change title or ownership of an asset from a deceased person’s name to that of the prospective heir(s). Probate property is distributed according to the decedent's will — if there is one — or according to state law if no will exists. Through the probate process, a person’s estate is settled by an executor – typically someone designated in advance. And all of this happens publicly as the probate process is a public proceeding.
According to the American Bar Association, the probate process, on average, takes approximately six to nine months to complete after a case is opened with the court. The timeline can vary depending on the court and may take years if there are disputes over the legality of the will or distribution of any assets. After the death of a family member, the last thing any relative wants to do is sit through meetings with attorneys and court proceedings for months on end.
The duties of an executor go beyond the probate process. They typically include filing and paying any federal and state estate taxes in addition to notifying and distributing assets to designated beneficiaries. The executors, administrators, and attorneys representing an estate are, of course, entitled to be compensated for their work. And as such, the probate process is neither cheap nor free. It is common in an area like Washington, D.C. for a service provider to compute their fee for services as a percentage of the assets included in the estate, typically 5% but sometimes more.
The probate court in your state of residence does not have the same authority in other states. If you own property in more than one state and choose to rely on a will to distribute your property at death, your executor will have to go through probate in each state. This process is referred to as “ancillary probate” and must be done in each state where one owns property. In addition to the expense and inconvenience that often accompanies the probate process, ancillary probate may take place in a state far from where an executor is located, forcing them to depend on an unknown local attorney and adding additional fees to an estate.
Since only property that is owned in a person’s individual name is subject to probate, one popular solution is to utilize a living trust. A living trust is a legal document that indicates which asset will transfer to appointed beneficiaries and subsequently removes direct ownership of that asset from an individual’s name and instead places it in the name of an entity. This way, any property and its intended recipient(s) is documented and will bypass the probate process altogether. The person(s) for whom the trust is created maintains both control of and access to the assets listed within as a trustee. And once that person passes away, the assets held within the trust are distributed according to the instructions they arrange.
A living trust is not necessary for every estate planning situation. Living trusts are a somewhat sophisticated planning tool and can sometimes be imposed on people whose financial situation is not complex enough to warrant it. However, owning real estate in more than one state is a great reason to consider contacting an estate planning attorney. Additionally, a properly constructed living trust can help keep your estate private, protect your assets from your heirs' creditors, and apply restrictions to any beneficiaries who may not be adept at managing money themselves.
Want more on this topic? Read these:
Life Insurance Is Not a Financial Plan
Just Inherited a Retirement Account from a Loved One? Here’s How to Keep the IRS from Taking Half
Just Inherited a House from a Relative? Here’s What You Should Know
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Malcolm Ethridge, CFP® is the Managing Partner of Capital Area Planning Group based in Washington, DC. He is also the Managing Partner of Capital Area Tax Consultants.
Malcolm’s areas of expertise include retirement planning, investment portfolio development, tax planning, insurance, equity compensation and other executive benefits.
Disclosures:
The information provided is for educational and informational purposes only, does not constitute investment advice, and should not be relied upon as such. Be sure to consult with your legal advisors before taking any action that could have tax and legal consequences.
Investments in securities and insurance products are:
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