Residential real estate continues to be a significant asset in most estates we plan. It also continues to cause considerable issues with the estates and trusts we administer. Whether caused by poor financial planning, poor estate planning or poor execution, the result is always the same – increased family discord, frustration and expense during administration after death. The solution is to get good advice tailored to your personal circumstances. Consider the remainder of this article a variety pack of issues related to residential real estate, including fraud, co-ownership, financing and titling issues.
Maricopa County recently released its free service to keep residents informed and take steps to prevent title fraud. Users who sign up for the service will receive an email notification when a document is recorded under a name they are monitoring. Both personal and business names can be monitored. To sign up visit: https://recorder.maricopa.gov/MaricopaTitleAlert/. This is similar to other fee-based credit monitoring services.
Vacation residences are filled with fond family memories. They also are a rat’s nest of problems related to co-ownership, use, upkeep, maintenance, taxes and capital improvements. The dream that generations of family members will hold on to and fund the family compound is somewhat of a fairy tale unless family members are willing to sacrifice the capital necessary to fund insurance, property taxes, maintenance and improvements. Solutions vary, but giving flexibility to future generations is key as you never know what is going to come up in the future. For more on this topic consider reading “Saving the Family Cottage: Creative Ways to Preserve Your Cottage, Cabin, Camp or Vacation Home for Future Generations” by Stuart and Rose Hollander.
Borrowing money secured by residential real estate is a relatively cheap source of funds. First and second mortgages, home equity lines of credit and reverse mortgages can provide liquidity, often with income tax advantages. Federal law permits borrowers to transfer residential property without trigging the due on sale provisions if: (i) the transfer is to a relative resulting from the death of the borrower, (ii) the spouse and children of the borrower become an owner of the property, or (iii) a transfer to a trust which the borrower remains a beneficiary and does not relate to a transfer of occupancy rights, such as most most revocable trusts. 12 U.S. Code § 1701j–3(d). These beneficiaries take the residence subject to the loan and the beneficiaries may retain the loan pursuant to its terms after the obligor’s death if they continue making payments. However, unlike other forms of loans, reverse mortgages may not be continued indefinitely by the successors and will need to be paid off, either with other funds or through the sale of the property.
Ways to Hold Title to Residential Real Estate in Arizona.
There are a variety of ways to hold title to residential real estate and the proper titling impacts your financial and estate plan. Again, there is no one magic solution that fits every situation and how to hold title depends on your particular circumstances. Below are just a few of the more common ways to hold title and when they are used.
- Community Property With Rights of Survivorship. The most common form of ownership in Arizona for a married couple without a trust. Title is held as community property and upon the death of the first spouse to die, title is transferred outright to the surviving spouse without probate. The surviving spouse receives a step-up in the cost basis on the entire property, so when he or she decides to sell the property, the basis for determining capital gains will be its fair market value at the time of first spouse’s death. Probate may be necessary upon incapacity and there are no restrictions on to whom the surviving spouse may transfer the property or its equity.
- Joint Tenants with Rights of Survivorship. Similar to Community Property with Rights of Survivorship, but for unmarried co-owners. Title is held jointly and upon the first owner’s death, title passes to the survivor outright without probate. The co-owner receives a step-up only on the deceased owner’s share of the property. Probate may be necessary upon incapacity and there are no restrictions on to whom the surviving owner may transfer the property or its equity.
- In Trust. Holding property in trust allows the owners to dictate ownership, control and use of the property, without adverse tax consequences. Upon the first owner’s death, use of the property may remain with the other owner, but that owner may be restricted from alienating the interest of the first owner’s beneficiaries upon the survivor’s death. Management may be delegated to a third party as trustee, with fiduciary duties designed to protect the rights of both the current income beneficiary as well as the remainder beneficiary. Probate will not be necessary upon incapacity or death of either owner. If the trust is owned by spouses, the property may receive a step up in basis on the entire property, not just the deceased’s half. The property may be sold and the proceeds retained for the benefit of one party, again without probate. Holding property in trust is the most flexible form of ownership as the parties may define separate management and control from beneficial use of the property. For these reasons, holding residential real estate in trust is usually the preferred method of holding title to property in Arizona.
- In a Limited Liability Company. Titling residential real estate in the name of a limited liability company (LLC) has the advantage over other forms of title because the LLC acts as a shield, protecting the assets of the owners from a liability occurring on the property. Whether the interest in the LLC is subject to probate upon incapacity or death depends on how the interest in the LLC is held (i.e. with survivorship or in trust). Similar to a trust, the management of the LLC may be separated from the use of its assets and the tax attributes may be allocated among the members in a variety of ways. Using an LLC to hold property is common if the property is held for investment or rented to third parties. Stacking LLCs can also provide a degree of confidentiality, but this also creates complexity.
- Tenants in Common. Title is taken in both names with each party owning their share separately. There is no survivorship, so on the death or incapacity of an owner, their share of the property will most likely be subject to probate and pass to the deceased owner’s heirs and not the other owner. This form of title is used for oil and gas and mineral rights so the owners retain the income tax benefits and unrelated co-owners who desire their share of the property to be distributed to different beneficiaries, such as in a second marriage scenario. However, without a well structured management agreement, holding title in this manner is fraught with ownership, control and benefit issues and a well drafted trust is often a better solution.
- Beneficiary Deed. This type of deed is similar to a beneficiary designation on an account. The owner retains title to the property, but upon the owner’s death title transfers to the beneficiary outright and without probate. The beneficiary receives a full step in basis. Probate may be necessary upon incapacity and there are no restrictions on to whom the beneficiary may transfer property or its equity. This technique is viable for a property with little equity and only one beneficiary.