10 Estate Planning Considerations for Out-of-State Property, 0816 COBJ, Vol. 45, No. 8 Pg. 53

AuthorJennifer Spitz, J.

45 Colo.Law. 53

10 Estate Planning Considerations for Out-of-State Property

Vol. 45, No. 8 [Page 53]

The Colorado Lawyer

August, 2016

Trust and Estate Law

Jennifer Spitz, J.

This article discusses 10 factors that should be considered in addressing out-of-state property as part of a well considered estate plan.

Clients residing in Colorado often own property in other states. The property may be a vacation home, rental property, a family farm, mineral interests, a timeshare, or some other asset. If a Colorado client owns property, especially real property, in another state, several issues should be considered in determining how to best integrate that asset into the client’s estate plan.

This article addresses 10 estate planning considerations for out-of-state property. It is not an exclusive list of the issues that may arise.

1. Ancillary Probate Versus Avoiding Probate

If probate is opened in Colorado and a personal representative is appointed by a Colorado court, the personal representative does not necessarily have authority over probate assets located in another state. Typically, “ancillary” probate will be required in the other state to establish the personal representative’s authority to deal with assets there. Because this will require time and expense that would not be necessary if the out-of-state assets were to pass outside of probate, attorneys should evaluate on a case-by-case basis whether steps should be taken while the client is alive to avoid ancillary probate.

If probate in the other state will not be complicated, ancillary probate may be a viable option Colorado has a simplified ancillary probate system, titled “Proof of authority,”1 and many other states have a similar option. Under this system, if a probate matter is not pending in the state where the out-of-state asset is located, probate can be opened in the state of domicile, and the personal representative may file with the court in the ancillary state authenticated copies of the appointment documents. In some situations, ancillary probate may cost less than avoiding probate.

When ancillary probate will be costly and time-consuming, it may be worthwhile for the client to avoid probate by converting a probate asset into a non-probate asset.

One common way to avoid probate in Colorado and other states is to transfer assets to a revocable trust. The trust can be fully funded to avoid probate or, alternatively, the trust could be funded with just the out-of-state assets, to avoid ancillary probate, with the client relying on Colorado probate and a pour-over will (which adds assets to the trust at death) for the Colorado assets.

A second option to avoid probate is to hold title in joint tenancy or tenancy by the entirety. For example, spouses who intend to leave their assets outright to each other can hold out-of-state property in joint tenancy with rights of survivorship or in tenancy by the entirety (discussed further below) and avoid probate of such property at the first spouse’s death. (A different technique would have to be employed after the first spouse dies to avoid probate at the surviving spouse’s death.) However, there are drawbacks to holding property as joint tenants with a non-spouse, so titling property in joint tenancy with a non-spouse is rarely the best solution.

A third option to avoid probate is to use a beneficiary deed, which is also known as a transfer-on-death deed. Several states allow for creation of a beneficiary deed,2 which operates like a payable-on-death designation on a bank account: The deed names a person to receive the property upon the owner’s death, allowing the property to pass to the named beneficiary outside of probate. The beneficiary does not have any ownership rights to the property during the owner’s life, and the owner can revoke the deed at any time. The beneficiary deed works best when the distribution plan is fairly straightforward; for example, when it names one person as the beneficiary. In contrast, if the deed designates as beneficiaries the owner’s “descendants, taking by representation” rather than including the names and ownership percentages for each beneficiary, a title issue may result.

Finally, the property could be transferred to a Colorado limited liability company (LLC) or other business entity. If the property is transferred to a Colorado LLC or other business entity, then neither the LLC nor the underlying asset should be subject to probate in the other state. This technique can be especially useful when there are other benefits to holding the asset in a business entity, such as liability protection,3 gifting, and succession planning. Keep in mind that if property is transferred to a Colorado business entity, the entity may also need to be registered as a foreign LLC with the state where the property held by the entity is located, in which case annual reports will likely be required in both states.4

2. State Estate Tax

Colorado does not currently impose an estate tax or an inheritance tax,5 but close to 20 states impose these taxes.6 A client who re sides in Colorado and owns property in a state that imposes state estate tax or inheritance tax may be subject to that tax. The techniques discussed above to avoid ancillary probate, such as transferring the out-of-state asset to a revocable trust, do not necessarily avoid state estate tax.

One of the challenges with planning for other states’ estate taxes is that tax systems vary by state. Some states impose an estate tax that operates similar to the federal estate tax but may have a different exclusion amount than that offered under the federal tax system. For example, in Oregon, the exclusion amount is $1 million.7 Other states impose an inheritance tax whereby the rate of tax is determined by the relationship of the decedent to the recipient. For ex ample, in Nebraska, there is a zero inheritance tax rate on property passing to a spouse, 1% to “immediate relatives,” 13% to “re mote relatives,” and 18% to other recipients.8

If a client owns property in another state, the planner should determine whether that state imposes an estate tax. If it does, the next step is to analyze whether state estate tax will be due. For ex ample, if the total value of the client’s estate is below the state’s exclusion amount, state estate tax will not be due and therefore it may not be necessary to take any steps to plan with state estate tax in mind. If state estate tax will be due, planning options should be considered to reduce or eliminate the tax due.

One option to eliminate estate tax in another state for a Colorado resident is to transfer the property to a Colorado business entity. Real property in a state that imposes estate tax (e.g., New York) could be transferred to a Colorado LLC or other business entity, thereby converting the property to intangible property, which may avoid state estate tax if the client is a Colorado resident. Accordingly, transferring the out-of-state property to an LLC or other business entity may be preferable to transferring the property directly to a revocable trust when state estate tax is a consideration. However, the state where the real property is located may still tax the underlying real estate if the business entity is a single-member LLC or if the business entity lacks a business purpose.9

Another option to eliminate state estate tax is to gift the out-of state assets to an irrevocable trust or outright to the next generation. Few states impose a gift tax; however, federal gift tax and other implications must be considered before gifting an asset.

Planners should also consider taking advantage of the state estate tax exclusion amounts for each spouse. Few states offer portability for state estate tax purposes.[10] Because so few states allow portability for the state exclusion amount, to take advantage of each spouse’s state estate tax exclusion amount, it may be advisable to leave the first spouse’s ownership interest in out-of-state assets (located in states that impose estate tax) to a bypass trust that is not includable in the surviving spouse’s estate. Otherwise, if the state does not allow for portability, the use of the...

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