Passing the family residence to one's spouse or children after death: Should transfer be directly or in trust?

• Author: Lerman, Jerry L.
• Position: Estate planning

In devising a will, a testator must consider an appropriate vehicle for passing various assets to loved ones. Assets may be given outright, in trust or under some other custodial arrangement. Although the testator may wish that his beneficiary could gain possession of the property shortly after the testator's death, having the inheritance pass to a trust or under some other custodial arrangement often may be more prudent. For example, when beneficiaries include the testator's minor children (or legally or financially incompetent relatives), it would be especially appropriate to have the will create a trust by which a competent and experienced trustee could manage the assets for many years on behalf of the named beneficiaries. Additionally, having the assets pass in trust may provide protection from creditors that would not otherwise be available if those same assets passed directly to the intended beneficiaries.

An asset common to most estates is a personal residence. Often, the residence is held in joint tenancy or in a tenancy by the entirety, in which case the residence would not pass under the will but rather would pass to the remaining joint tenant under operation of law. If, however, the testator were the sole owner of the entire residence or if he held ownership as a tenant in common, he could provide in the will for its ultimate disposition. Typically, the testator would provide in the will that the residence pass outright to his surviving spouse or other relative. However, there are times when he would prefer it to pass in trust to his named beneficiaries.

In deciding whether to pass the residence outright to or in trust for an intended beneficiary, a testator may also wish to consider whether the beneficiary qualifies for exclusion under Sec. 121, should the beneficiary later decide to sell the residence. Under Sec. 121, a taxpayer may exclude from taxable income up to $250,000 of gain ($500,000 for qualifying married taxpayers filing jointly) incurred on a sale of his principal residence, if certain requirements are met. To qualify for this exclusion, the taxpayer must have owned and used the property as his principal residence for periods aggregating at least two years during the five-year period ending on the sale date.

If a testator bequeaths a residence outright to a beneficiary and the beneficiary uses the residence as a principal residence for the requisite period, the beneficiary will be entitled to the gain exclusion...