How to Title Your House To Avoid Probate
When we are working with clients on their estate plan, one of the primary objectives is to assist them with titling their assets so they avoid the probate process after they pass away. For anyone that has had to serve as the executor of an estate, you have probably had firsthand experience of how much of a headache the probate processes which is why it's typically a goal of an estate plan to avoid the probate process altogether.
When we are working with clients on their estate plan, one of the primary objectives is to assist them in titling their assets so they avoid the probate process after they pass away. For anyone that has had to serve as the executor of an estate, you have probably had firsthand experience with how much of a headache the probate process is. For that reason, it's typically a goal of an estate plan to avoid the probate process altogether.
While it’s fairly easy to protect an IRA, a brokerage account, bank accounts, and life insurance policies from the probate process, it has historically been more difficult to protect the primary residence from the probate process without setting up a trust to own the house.
But there is good news on this front, especially for residents of New York State. As of July 2024, New York allows residence to add a Transfer on Death (TOD) designation to their deed. Adding a TOD designation is like naming beneficiaries on an IRA account or brokerage account. Prior to July 2024, residents of New York State were not allowed to add a TOD designation to a deed for real estate, so their only ways to protect their house from the probate process was:
Gift the house to their child before they die (Not a good option)
Gift the house with a life estate (Ok….but not great)
Set up either a Revocable or Irrevocable Trust to own the house
Those three options are still available but now there is a fourth option which is simple and costs less money than setting up a trust. Change the deed on your house to a “TOD deed”.
32 States Now Allow TOD Deeds
While New York just made this option available in 2024, there were already 31 other states that already allowed residents to add a TOD designation to their deed. Depending on which state you live in, a simple Google search or contacting a local estate attorney, will help you determine if your state offers the TOD deed option.
What Is The Probate Process?
Why is it a common goal of an estate plan to have your assets avoid the probate process? The probate process can be expensive and time consuming depending on what state you live in. In New York, the state that we are located in, it’s a headache. Any asset that is not owned by a trust or does not have beneficiaries directly assigned to it, pass to your beneficiaries through your will. The process of moving assets from your name (the decedent) to the beneficiaries of your estate, it a formal legal process called the “probate process”.
It is not as easy as when someone passes away with a house, they just look at their will which list their children as beneficiaries of their estate, and then the ownership of the house is transferred to the kids the next day. The probate process is a formal legal process in which the court system is involved, an estate attorney may need to be hired to help the executor through the probate process, an accountant may need to be hired to file an estate tax return, an appraiser may need to be hired to value real estate holdings, and investment advisors may be involved to help retitle assets to the beneficiaries. All of this costs money and takes time to navigate the process. We have seen some estates take years to settle before the beneficiaries receive their inheritance.
How Assets Pass to Beneficiaries of an Estate
There are three ways that assets pass to a beneficiary of an estate:
Probate
By Contract
By Trust
Assets That Pass By Contract
Assets that pass “by contract” to beneficiaries of an estate avoid the probate process because there are beneficiaries contractually designated on those accounts. Examples of these types of assets are retirement accounts, IRAs, annuities, life insurance policies, and an asset with a TOD designation like a brokerage account, bank account, or a house with a TOD deed. For these types of assets, you simply look at the beneficiary form that was completed by the account owner, and that's who the account passes to immediately after the decedent passes away. It does NOT pass by the decedent’s will.
Example: Someone could list their two children as 50/50 beneficiaries of their estate in their will but if they list their cousin as their 100% primary beneficiary on their IRA, when they pass away, that IRA balance will go 100% to their cousin because IRA assets transfer by contract and not through the probate process. Any assets that go through the probate process are distributed in accordance with a person’s will.
Asset That Pass By Trust
One of the primary reasons for an individual to set up either a revocable trust or irrevocable trust to own their house or other assets is to avoid the probate process, because assets that are owned by a trust pass directly to the beneficiaries listed in the trust document outside of the will. Example: your brokerage account is owned by your Revocable Trust, when you pass away, the assets can be immediately distributed to the beneficiaries listed in the trust document without going through the probate process. The beneficiaries listed in your trust document may or may not be different than the beneficiaries listed in your will.
House With A Transfer of Death Deed
Prior to New York allowing residents to attach a TOD designation to the deed on their house, the only options for titling the house to avoid the probate process were to:
Gift the house to the kids before they pass (not a good option)
Gifting the house with a life estate
Setting up a trust to own the house
The most common solution was setting up a trust to own the house which costs money because you typically have to engage an estate attorney to draft the trust document. If the ONLY objective of establishing the trust was for the house to avoid probate, the new TOD deed option could replace that option and be an easier, more cost-effective option going forward.
How To Change The Deed to a TOD Deed
Changing the deed on your house to a TOD deed is very simple. You just need to file the appropriate form at your County Clerk’s Office. The TOD designation on your house does not become official until it has been formally filed with the County Clerk’s Office.
What If You Still Have A Mortgage?
Having a mortgage against your primary residence should not preclude you from changing your current deed to a TOD deed. Even after you file the TOD deed, you still own the house, the bank still maintains a lien against your house for the outstanding amount, and even if you pass and the house transfers to the kids via the TOD designation, it does not remove the lien that the bank has against the property. If the kids tried to sell the house after you pass, they would first need to satisfy the outstanding mortgage, potentially with proceeds from the sale of the house.
The TOD Deed Does Not Protect The House From Medicaid
While changing the deed on your house to a TOD deed will successfully help the house to avoid the probate process, it does not protect the house from a future long-term care event. While the primary residence is not a countable asset for Medicaid, Medicaid, depending on the county that you live in, could put a lien against your house for the amount that they paid to the nursing home for your long-term care. Individuals that want to fully protect their house from a future long-term care event will often set up an Irrevocable Trust, otherwise known as a Medicaid Trust, to own their house to avoid these Medicaid liens. That is an entirely different but important topic that we have a separate article on. If you are looking for more information on how to protect your house from probate AND a long-term care event, here are our articles on those topics:
Article: Gifting Your House with a Life Estate vs Medicaid Trust
Article: Don’t Gift Your House To Your Children!!
Article: How to Protect Assets From A Nursing Home
Changing the House TOD Beneficiaries
The question frequently comes up during our estate planning meetings, “What if I change my mind on who I want listed as the beneficiary of my house?” With a TOD Deed, it’s an easy change. You just go back to the County Clerks Office and file a new TOD Deed with your updated beneficiary designations. Remember, once you Change the deed to a TOD deed, the house no longer passes in accordance with your will, it passes by contract to the beneficiaries list on that TOD designation.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
A CFP® Explains: Wills, Health Proxy, Power of Attorney, & Trusts
When we are constructing financial plans for clients, we inevitably get to the estate planning portion of the plan, and ask them “Do you have updated wills, a health proxy, and a power of attorney in place?
When we are constructing financial plans for clients, we inevitably get to the estate planning portion of the plan, and ask them “Do you have updated wills, a health proxy, and a power of attorney in place?” The most common responses that we receive are:
“I know we should have but we never did”
“I did but it was over 10 years ago”
“I have a will but not a health proxy or a power of attorney”
“I have heard about trusts, should I have one?”
The Will, Health Proxy, and Power of Attorney are the three main estate documents that most people should have. In this article I will review:
How Wills work and items that you should include in your Will
Why you should have a Health Proxy and how they work
Power of Attorney
The probate process
Considering a testamentary trust
Assets that pass outside of the Will
Revocable Trusts & Irrevocable Trusts
Estate planning tips
How much does it cost to establish a will, health proxy, and a power of attorney
Establishing A Will
The most basic estate document that most people are aware of is a written Will. The Will provides specific guidance as to who will receive your assets after you have passed away. The Will also establishes who would be the guardian of your minor children should you pass away prior to your children reaching the age of majority. Without a Will, state laws and the court system that know nothing about you, will decide who receives your assets and who will be the guardian of your minor children; not a situation that most people want.
The Will can be a very simple document. If you are married and have children, the Will may state that if you pass away everything goes to your spouse but if both you and your spouse were to pass away simultaneously, the assets go to the children. For individuals or married couples without children, or for married couples that have been divorced, it’s also critical to have a Will to provide direction as to what will happen to your assets if you were to pass away.
You can engage an estate attorney to complete a simple Will or if your Will is very simple and straightforward, you may elect to use a do-it-yourself option through a platform like Legal Zoom. We typically encourage clients to meet with an estate attorney because when it comes to estate planning many people don’t know what questions to ask to get the right documents and plan in place. If you are married with minor children, and you and your spouse were to pass away leaving all the assets to the kids, with a simple Will, they would have access to their full inheritance at age 18. An 18 year old having access to large sums of money may not be an optimal situation. In those cases, you may want to include a testamentary trust or revocable trust in your estate plan to put some restrictions in place as to how and when your children will have access to their inheritance.
Probate
I'm going pause here for a moment and explain what probate is and the probate process. When someone passes away, all of the assets included in their estate go through what's called a “probate process”. The probate process is a legal process of accounting for all of your assets, debts, and transferring your assets to the beneficiaries of your estate. The person listed in your will as the “executor” is responsible for coordinating the probate process. Depending on the size of the estate, your executor will usually work with an attorney, an accountant, and possibly appraiser, to:
Value the assets in your estate
Work with the courts to process your estate
Pay outstanding expenses or debts
Coordinate the transfer of assets to your beneficiaries
Since the probate process is a legal process involving the courts, the process often takes longer than beneficiaries expect. Individuals will make the incorrect assumption that when you pass away, they just read the will, and your beneficiaries receive the assets within a few days or weeks; unfortunately that's not that case. It’s not uncommon for the probate process to take 6 to 12 months and there are expenses involved with probating an estate. If it’s a complex estate, it could take over a year to complete the probate process.
For these reasons, it’s a common goal with estate planning to find ways to avoid the probate process and pass you assets directly to your beneficiaries. I will explain more about these strategies later on. But circling back to our discussion about the Will, if all you have is a Will, when you pass away, the assets in your estate will pass through this probate process.
Testamentary Trusts
There are a lot of different types of trusts within in estate planning world. One of the most basic and common trusts, especially for individuals with children under that age of 25, is a testamentary trust. A testamentary trust is a trust that is built into your will. With at testamentary trust, you are not establishing a trust today , but rather, if you pass away, a trust is established during the probate process and you can direct assets to the trust. Building a testamentary trust into your Will gives you some control over how the assets are distributed to the beneficiaries after you have passed away.
It's common for individuals or married couples with children under that age of 25, to build these testamentary trusts into their Wills. I will illustrate how these trusts work in the example below.
Example: Jim and Sarah have two children, Rob age 14 and Wendy age 8. Between the value of their house, life insurance policies, and other assets, their estate would total $1.5M. Jim & Sarah realize that if something were to happen to them tomorrow, they would not want their kids to inherit $1.5M when they turn age 18 because they might not go to college, they may try to start a business that fails, buy a Corvette, etc. In their Will they establish a Testamentary Trust that states that if both parents pass away prior to the children turning age 25, all of their assets will flow into a trust, and that Sarah’s brother Harold will serve as the trustee. Harold as the trustee is able to distribute cash from the trust for living expenses, education, health expenses, and other expenses deemed necessary for the well being of the children. The children will receive 1/3 of their inheritance at age 25, 30, and 35.
You can design these testamentary trusts however you would like. In the Will you would designate who will be the trustee of your trust and the terms of the trust.
IMPORTANT NOTE: Testamentary trusts do not avoid probate like other trusts do. The trust is established as part of the probate process.
Revocable Trusts & Irrevocable Trusts
It's also common for individuals and married couples to consider establishing either a Revocable Trust or Irrevocable Trust as part of their estate planning. These are separate from Testamentary Trusts. Revocable Trusts and Irrevocable Trusts are being established today and assets owned by the trust pass in accordance with the terms set forth in the trust document. There are material differences between these two types of trusts but some primary reasons why people establish these types of trust are to:
Avoid probate
Protecting assets from a long term event
Control how and when assets are distributed beyond the date of death
Reducing the size of the estate
Advanced tax strategies
Assets That Pass Outside of The Will
There are certain assets that pass outside of the Will. Many of these “other assets” pass by “contract”, meaning there are beneficiaries designated on those accounts. A common example of assets that pass by contract are 401(k) accounts, IRA’s, annuities, and life insurance. When you set up those accounts you typically designate beneficiaries for each account and your Will could say something completely different. The assets that pass by contract do not have to go through the probate process unless the beneficiary listed on the account is your estate which is usually not an advantageous election for most individuals.
Transfer On Death Accounts (TOD)
One of the estate planning strategies that we use with clients is instead of holding an individual investment account in the name of the individual, we will register the account as a “transfer on death” (TOD) account. If you have an individual brokerage account and you pass away, the value of that account will have to go through probate. By simply adding the TOD feature to an existing individual brokerage account which lists beneficiaries similar to a 401(K) or IRA account, that account now avoids probate, and passes by contract directly to the beneficiaries.
Depending on the assets that make up your estate, you may be able to setup TOD accounts as opposed to going through the process of setting up trusts but it varies from person to person.
Power of Attorney
Let’s shift gears now over to the Power of Attorney document. A Power of Attorney document is important because it allows someone to step into your shoes and handle your financial affairs, should you become incapacitated. Some common examples are:
Example 1: If you're in a car accident and end up in a coma, for accounts that are held only in your name, such as a checking account, investment account, or credit card, they will only speak to you. Being married does not give your spouse access financially to those accounts while you are still alive but your spouse may need access to them to continue to pay your bills or get access to cash to pay expenses while you're incapacitated. Having a power of attorney document would allow your spouse or trusted individual named as your “agent” to act financially on your behalf.
Example 2: Having a power of attorney in place is key for Long Term Care events. If you have a spouse or parent and they have a stroke, develop dementia, or another health event that renders them unable to handle their personal finances, you could step in as their agent and handle their personal finances. In long term care situations that can often mean paying a nursing home, applying for Medicaid, paying medical bills, or shifting the ownership of assets to protect from a Medicaid spend down.
The Power of Attorney can also be built so your agent is not given that power today but rather it would only be given if a triggering event happened sometime in the future. With this document you really have to name someone you 100% trust. As financial planners, we have seen cases where there is abuse of the Power of Attorney powers and it’s never pretty. It's not uncommon for a power of attorney to allow the agent to make gifts as a planning tool, but that might also include gifts to themselves, so you have to fully trust your agent and the powers that you provide to them.
Health Proxy
The health proxy is usually the least fun estate document to complete but is equally important. In this document you are naming the individual that has the right to make your health decisions for you if you are incapacitated. This document spells out what you want and don’t want to have happen if certain health events occur. While it's not uncommon for individuals to be a little uncomfortable completing this document due to the nature of the questions, it's a lot better to complete it now, versus your family members trying to determine what your wishes would be when a severe health event has already occurred.
The health proxy will list items like:
Would you be willing to be put on life support?
If you could not eat, would you allow them to use a feeding tub
Resuscitation preferences
Willingness to accept blood transfusions
Again, not fun things to think about but by you making these decisions while you are of sound body and mind, it takes away the difficult situation where your family members have to decide in the heat of the moment what you would have wanted. That situation can sometimes tear families apart.
Keep Your Estate Plan Up To Date
All too often, we run into this situation where a client will acknowledge that they have estate documents, but they were established 20 years ago, and they never made any changes. It makes sense to meet with your estate attorney and revisit your estate plan:
Every five years
If you move to a different state
When Congress makes major changes to the estate tax rules
The estate laws vary state by state. If we have clients that are planning to move and they plan to change their state of domicile to another state, we will often encourage them to meet with an estate attorney within that state once the move is complete. Congress has also made a number of changes to the federal estate tax laws over the past few years, with potentially more in the works, and not revisiting the estate plan could end up costing your beneficiaries tens of thousands of dollars in estate taxes that could have been avoided with some advanced planning.
Cost of Estate Documents
The cost of establishing a Will, Health Proxy, Power of Attorney, and Trusts, often varies based on the complexity of your estate plan. A simple Will may cost less than $1,000 to establish through an estate attorney. Establishing all three documents: Will, Health Proxy, and Power of Attorney may cost somewhere between $1,000 - $3,000. While it's not uncommon for individuals to be surprised by the cost of setting up these estate documents, I always urge people to think about the cost of not having those documents in place. The probate process with professionals involved could cost thousands of dollar, your beneficiaries could lose thousands of dollars in taxes that could have been avoided, not to mention the emotional toll on your family trying to figure out what you would have wanted without clear guidance from your estate documents. Revocable Trusts and Irrevocable Trust
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Do I Have To Pay Tax On A House That I Inherited?
The tax rules are different depending on the type of assets that you inherit. If you inherit a house, you may or may not have a tax liability when you go to sell it. This will largely depend on whose name was on the deed when the house was passed to you. There are also special exceptions that come into play if the house is owned by a trust, or if it was gifted
Do I Have To Pay Tax On A House That I Inherited?
The tax rules are different depending on the type of assets that you inherit. If you inherit a house, you may or may not have a tax liability when you go to sell it. This will largely depend on whose name was on the deed when the house was passed to you. There are also special exceptions that come into play if the house is owned by a trust, or if it was gifted with the kids prior to their parents passing away. On the bright side, with some advanced planning, heirs can often times avoid having to pay tax on real estate assets when they pass to them as an inheritance.
Step-up In Basis
Many assets that are included in the decedent’s estate receive what’s called a step-up in basis. As with any asset that is not held in a retirement account, you must be able to identify the “cost basis”, or in other words, what you originally paid for it. Then when you eventually sell that asset, you don’t pay tax on the cost basis, but you pay tax on the gain.
Example: You buy a rental property for $200,000 and 10 years later you sell that rental property for $300,000. When you sell it, $200,000 is returned to you tax free and you pay long-term capital gains tax on the $100,000 gain.
Inheritance Example: Now let’s look at how the step-up works. Your parents bought their house 30 years ago for $100,000 and the house is now worth $300,000. When your parents pass away and you inherit the house, the house receives a step-up in basis to the fair market value of the house as of the date of death. This means that when you inherit the house, your cost basis will be $300,000 and not the $100,000 that they paid for it. Therefore, if you sell the house the next day for $300,000, you receive that money 100% tax-free due to the step-up in basis.
Appreciation After Date of Death
Let’s build on the example above. There are additional tax considerations if you inherit a house and continue to hold it as an investment and then sell it at a later date. While you receive the step-up in basis as of the date of death, the appreciation that occurs on that asset between the date of death and when you sell it is going to be taxable to you.
Example: Your parents passed away June 2019 and at that time their house is worth $300,000. The house receives the step-up in basis to $300,000. However, lets say this time you rent the house or don’t sell it until September 2020. When you sell the house in September 2020 for $350,000, you will receive the $300,000 tax-free due to the step-up in basis, but you’ll have to pay capital gains tax on the $50,000 gain that occurred between date of death and when you sold house.
Caution: Gifting The House To The Kids
In an effort to protect the house from the risk of a long-term event, sometimes individuals will gift their house to their kids while they are still alive. Some see this as a way to remove themselves from the ownership of their house to start the five-year Medicaid look back period, however, there is a tax disaster waiting for you with the strategy.
When you gift an asset to someone, they inherit your cost basis in that asset, so when you pass away, that asset does not receive a step-up in basis because you don’t own it and it’s not part of your estate.
Example: Your parents change the deed on the house to you and your siblings while they’re still alive to protect assets from a possible nursing home event. They bought the house 30 years ago for $100,000, and when they pass away it’s worth $300,000. Since they gifted the assets to the kids while they were still alive, the house does not receive a step-up in basis when they pass away, and the cost basis on the house when the kids sell it is $100,000; in other words, the kids will have to pay tax on the $200,000 gain in the property. Based on the long-term capital gains rates and possible state income tax, when the children sell the house, they may have a tax bill of $44,000 or more which could have been completely avoided with better advanced planning.
How To Avoid Paying Capital Gains Tax On Inherited Property
There are ways to both protect the house from a long-term event and still receive the step-up in basis when the current owners pass away. This process involves setting up an irrevocable trust to own the house which then protects the house from a long-term event as long as it’s held in the trust for at least five years.
Now, we do have to get technical for a second. When an asset is owned by an irrevocable trust, it is technically removed from your estate. Most assets that are not included in your estate when you pass do not receive a step-up in basis; however, if the estate attorney that drafts the trust document puts the correct language within the trust, it allows you to protect the assets from a long-term event and receive a step-up in basis when the owners of the house pass away.
For this reason, it’s very important to work with an attorney that is experienced in handling trusts and estates, not a generalist. It only takes a few missing sentences from that document that can make the difference between getting that asset tax free or having a huge tax bill when you go to sell the house.
Establishing this trust can sometimes cost between $3,000 and $6,000. But by paying this amount upfront and doing the advance planning, you could save your heirs 10 times that amount by avoiding a big tax bill when they inherit the house.
Making The House Your Primary
In the case that the house is gifted to the children prior to the parents passing away and the house is not awarded the step-up in basis, there is an advance tax planning strategy if the conditions are right to avoid the big tax bill. If one of the children would be interested in making their parent’s house their primary residence for two years, then they are then eligible for either the $250,000 or $500,000 capital gains exclusion.
According to current tax law, if the house you live in has been your primary residence for two of the previous five years, when you go to sell the house you are allowed to exclude $250,000 worth of gain for single filers and $500,000 worth of gain for married filing joint. This advanced tax strategy is more easily executed when there is a single heir and can get a little more complex when there are multiple heirs.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
