A home can go into an irrevocable trust. But giving up control over a primary residence is not something most owners want to do. The owner lets go of the “incidents of ownership” and the house goes under a separate tax ID, with taxes filed by a trustee. The owner might continue living in the home, but the house essentially becomes a vessel to hold property for the named beneficiaries.
Any homeowner’s financial circumstances and goals can change, and so can their relationships with potential beneficiaries: family, friends, and charities. This is why an irrevocable trust makes sense only in rare situations.
The Irrevocable Trust Differs From a Living Trust.
Trusts can hold assets, including houses, for chosen beneficiaries. The trustee is the party who handles the trust’s expenses, who hires an accountant to files its taxes (if it generates income), and who serves as a dependable steward on behalf of the beneficiary.
The trustee can be a competent adult or a corporation. There are lawyers and professional services available to manage trusts.
As a homeowner, you could be the trustee for your own living trust, also called a revocable trust. The revocable trust remains under your control and your personal tax ID, and you can take the house out of it or change the beneficiary as you see fit. You may end the trust, remove the house from the trust, or change your designated beneficiaries.
But once the house title is conveyed to the irrevocable trust, you’ve given it up to the trust, which will own it throughout your life. You cannot change the beneficiary from, say, your child to a charity. You cannot modify the terms, such as the timing in the agreement for your child to receive the assets. And you may not, of course, revoke this kind of trust.
Selling the house — during or after the trust creator’s life — is not the trust creator’s role but rather the trustee’s job to initiate, if the home’s title is not ultimately conveyed to the beneficiaries. The trustee can hire a real estate agent. Most do, as hiring a professional will assure the beneficiaries that the transaction was professionally handled.
Granted, most states do allow irrevocable trusts to be modified with the consent of the impacted parties, unless they are minors. But state law may require a court order or a non-judicial settlement agreement — a binding agreement tantamount to a judge’s order. Rigid arrangements like this don’t normally make sense for a house, which owners might like to borrow against or sell when they see fit.
In What Situations Do Irrevocable Trusts Work?
Four key reasons homeowners consider creating irrevocable trusts are these:
1. To minimize estate taxes on highly valuable properties.
Needless to say, the average homeowner doesn’t have this problem. As of 2021, federal estate tax applies only to taxpayers who have at least $11,700,000 in assets per person. Some states have their own estate tax and their own threshold, which can be lower.
Some trusts are set up to skip taxation until the second person in a couple dies. There are also generation-skipping trusts, which bypass tax for the children of the trust creator. These can be effective methods to preserve wealth for people with large estates. Keep in mind that nobody knows for sure what the threshold for estate taxes will be when they pass on. Federal and state tax policies change as government administrations change.
2. To preserve eligibility for long-term care.
By letting go of ownership of a home and placing it into an irrevocable trust, a person may be able to obtain Medicaid support for long-term care if needed. While Medicaid cannot force anyone to sell their home, the cost of long-term care is a lienable debt. This means Medicaid will sell the debtor’s house after death to reclaim its costs.
By transferring home ownership to an irrevocable trust, though, a person can keep the home until it passes to the chosen beneficiaries. This is what’s meant by the term Medicaid trust. For this to work, the house must be in the trust at least five years before Medicaid support is tapped. Before selling and buying a new house with the proceeds, the beneficiaries should know that the trust must sell the house and the trust must be buying another — to keep the value protected by the trust.
3. To shield assets.
Assets can be protected from creditors by an irrevocable or asset protection trusts. Where these methods are available under state law, they can be helpful to professionals whose work could be subject to lawsuits. That said, courts may order the protective shield lifted for fairness to prevail in a given case. And as with the Medicaid trusts, the trust’s asset protection is not effective immediately.
Pro tip: Both the availability of asset protection trusts and the need for them vary depending on the home’s state. In some states, homestead laws already shield primary residences from creditors to some extent.
4. To provide for a beneficiary’s special needs.
Some homeowners transfer their houses into revocable trusts to provide for children or adults who are disabled and need support. If providing for others’ special needs, the trust can be set up as revocable or irrevocable.
These goals are clearly different, and no trust is one-size-fits all. The trust agreement will be customized to fit its case-specific goals.
Alternatives to an Irrevocable Trust
Other trusts are also will substitutes. If your house is put into a revocable trust, the home transfer avoids the time and cost of probate, and your beneficiaries have immediate access to the house. There are several other strategies to avert probate, including looking at your title vesting options.
Or you might consider:
- A Revocable Trust. Create a revocable trust
to pass a home to non-spouse beneficiaries, and you can take that asset back if
necessary. Revocable trusts ultimately bypass probate yet stay within the
owner’s control, in the owner’s estate, and under the owner’s social security
number throughout life. They can hold assets for a child or children, and
distribute their value in increments, as young adults reach the specified ages.
- A Life Estate. As a life tenant,
an owner can live at home for life, then pass a beneficiary the remainder interest
in the property. By passing from one resident owner to the next in the form of
a remainder, the home circumvents probate. The title has both names on it, but
only one has the right to live in it at a time.
- An Enhanced Life Estate Deed. Some states
allow enhanced life
estate deeds, also called lady bird deeds. These are
revocable. They enable their life tenants to sell or take loans out on the
property if they so choose, change the remainder beneficiary, or take back the
interest.
Note that a trust created as revocable in life will become irrevocable once its creator dies or becomes incapacitated. At that point the trust cannot be amended or revoked. It then becomes an entity in itself, and its successor trustee must obtain a separate tax identity for it, and ensure that any remaining debts tied to a home in the trust are properly paid.
Bottom Line? It’s Complicated.
All the applicable legal rules must be carefully followed with an irrevocable trust. Otherwise, its protections can be lost. In some circumstances, and in some states, real estate may be taken out of Medicaid trusts. In other situations, assets in irrevocable trusts may be accessible for reverse mortgages. These activities depend on bank guidelines, and receipt of the beneficiaries’ permission. Putting a home with a mortgage into a trust is especially tricky, and involves significant advance planning and communication.
Consult a wills, estates and trusts attorney for case-specific guidance. An experienced attorney in your state can draft a trust agreement that is valid and effective — one that optimizes the potential financial and tax benefits of the irrevocable trust in your state.
Photo credits: Chris Mok and Guillaume de Germain, via Unsplash.