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Revocable Living Trusts and Real Estate

As a real estate agent I am often asked for advice from home buyers on how title in real estate should be taken and “What are the implications of setting up a Revocable Living Trust?”  Here I must defer to your CPA and/or attorney, as I am not licensed to give such advice, only to raise some question for you to pursue with those professionals.

Ease of Settling An Estate – In an attempt to avoid probate costs, court supervision, and public access to private information, many California homebuyers set up Revocable Living Trusts into which they place their assets, including their home.

  • Trust document needs to be created designating the names of the trustors, trustees, and beneficiaries.
  • Title of all real (and personal) property needs to be placed into the trust in the following way: “We, John Smith and Mary Smith, husband and wife, quitclaim to John Smith and Mary Smith, co-trustees of the Smith Family Trust, the real property…”
  • Important Notes: Some people forget to transfer all property into their trust (particularly after they refinance), which effectively nullifies the purpose of setting up the trust in the first place;  assets omitted from the trust may trigger a probate they were trying to avoid.  Correspondingly, if recorded quitclaim documents are not signed properly “_____, as trustee of the ____ trust” this can create a cloud on title that may complicate issuance of title insurance until corrections are made.

    Community Property – Normally, unless the trust instrument expressly provides other wise, community property that is transferred into a revocable living trust remains community property during the marriage, regardless of the identity of the trustee, if the trust provides that the power to modify the trust may be exercised only with the joinder or consent of both spouses.

    Capital Gains Tax – Merely setting up a Revocable Living Trust and placing property in it does not avoid capital gains tax.  Here’s a summary of some current federal capital gains tax laws:

    • The Taxpayer Relief Act of 1997 (the “1997 Act”) and the IRS Restructuring and Reform Act of 1998 (the “1998 Act”) provide for an exclusion from income for certain amounts of gain from the sale of a principal residence.
    • The Mortgage Forgiveness Debt Relief Act of 2007 (the “2007 Act”) also provides clarification regarding certain capital gains issues.
    • The Jobs and Growth Tax Relief Reconciliation Act of 2003 (the “2003 Act”) made important changes to the federal taxation laws including, among other matters, lower capital gains tax rates, acceleration of a reduction in tax rates, increased child tax credits and a reduction in the so-called marriage penalty.
    • Sunset provisions in the 2003 Act were extended by the Tax Increase Prevention and Reconciliation Act of 2005 (the “2005 Act”).
    • Recently, with the passage of H.R. 3221, the Housing and Economic Recovery Act of 2008, further changes were made to capital gains exclusions for a principal residence that wasn’t used as a principal residence part of the time of ownership.

    Exclusions from Gain – a $250,000 exclusion ($500,000 if married filing jointly) applies to a sale or exchange by a revocable living trust so long as the grantor of the trust and owner of the property before it was conveyed to the trust are the same person and that person, either as owner or grantor, has owned and used the property as his or her principal residence for two of the previous five years.

    Transferring Property into a Revocable Living Trust should not create a taxable event – IRC 676 provides that a grantor (the person who creates and funds the trust) is treated as the owner of the property when the grantor retains the power to revoke the trust and revest title in him or herself.  The 2003 Act does not change this provision. In other words, because the grantor is still treated as the owner of the property, the transfer into the trust is not a taxable event.

    Disclosures and Revocable Living Trusts – Since 1987 sellers or other transferors of real property containing one-to-four residential units have been required to furnish prospective buyers or other transferees with a completed Real Estate Transfer Disclosure Statement (TDS) on a specific form prescribed by law–unless exempt.

    Exception to TDS disclosure exemption - Transfers by a fiduciary in the course of the administration of a decedent’s estate, guardianship, conservatorship, or trust normally are exempt;  however, an exception to this exemption occurs when the property is held in a revocable trust and the trustee is a natural person who is the sole trustee of the trust as well as the former owner of the property or an occupant in possession of the property within the year preceding the transfer.  Further, it is always good practice for sellers to disclose everything (except as restricted by law) they know about the property that effects its value.

    Disclaimer – Again, the information above is from the California Association of Realtors legal questions and answers and is not to be construed as legal advice by this Realtor.  Please consult with your CPA or attorney for questions regarding your specific situation.