Copyright © 2014 by Robert M. Kramer.   All Rights Reserved.

Sometimes common legal problems are hard to solve.

For example, Dr. Kellogg’s mother, Mrs. Kellogg, a widow, died recently.  She owned a $300,000 homestead and various liquid investments. Her estate planning attorney set up a Revocable Trust and transferred all her assets, including the homestead, into it in order to “avoid probate”.   Dr. Kellogg, the successor trustee and sole beneficiary of the Revocable Trust, just found out that the title company is requiring a judicial determination of the homestead.  He also learned that in order to do this, a probate will have to be conducted as this is a prerequisite to a judicial determination. Result- several months delay in being able to convey good title to a third party-buyer and several thousand dollars in legal fees.

The problem is the homestead law, specifically, the restriction on certain transfers taking effect at death and the creditor protection aspect of the homestead.

Florida law provides that the homestead property cannot be devised if the decedent-owner was married or had minor children.  However, if there are no minor children, the owner could devise it to his or her spouse.  In the event there is at least one minor child (in which case no devise is permitted), all of the decedent’s children will share in the children’s portion.

Florida law also provides creditor protection rights- called “Exempt (Protected) Homestead”- if the homestead descends to the spouse and/or children, or if the decedent devised (if permitted) the property to an heir or heirs (a related person who could possibly inherit the property if there was no Will and without regard to the existence of other heirs with a higher priority).  In these events, the homestead is released by the Court from being an asset subject to the decedent’s debts to general creditors.

Recall that Mrs. Kellogg’s homestead was transferred into a Revocable Trust.  Since Mrs. Kellogg had the right to revoke the transfer and put the property back in her name, this was considered a testamentary disposition- a transfer that took effect at death- and therefore, subject to the homestead laws.   Thus placing the homestead in a Revocable Trust to avoid probate is illusory!

Moreover, there needs to be a judicial determination of whether Mrs. Kellogg could devise the property (i.e., she was not survived by a spouse or minor child), that the property was in fact her homestead, and that the property was conveyed to an heir.  If the Court so finds, the homestead would be released from Mrs. Kellogg’s general creditors, as assets in a Revocable Trust are generally available to the related probate estate to pay debts of the decedent.  In order to have a judicial determination of homestead, a probate proceeding will need to be conducted.

There is another complication- Income Taxes.  Most property inherited at death or otherwise includible in the gross estate for Federal Estate Tax purposes, receive a date of death basis. Mrs. Kellogg bought her homestead many years ago for $100,000 and it was worth $300,000 at the time of her death. If Dr. Kellogg subsequently sells the property for $300,000, there is no taxable income on the sale as the amount realized on the sale, $300,000 less the $300,000 tax basis is $0.  In contrast, if the homestead were conveyed by Mrs. Kellogg during her lifetime to her son, the tax basis would only be $100,000.  A subsequent sale by Dr. Kellogg for $300,000 less the $100,000 tax basis would result in a $200,000 gain to him.

Our solution to avoid probate and to obtain a date of death tax basis would have been to set up an Irrevocable Trust and have Mrs. Kellogg transfer the homestead property into it.  Mrs. Kellogg would be given a beneficial interest in the Trust property for her life (i.e., “life estate”) and Dr. Kellogg would be given a beneficial interest as remainderman.

Under this scenario, Section 2036 of the Internal Revenue Code treats the homestead property as part of Mrs. Kellogg’s gross estate for Federal Estate Tax purposes because transferring property to a donee, but retaining the property for life, is similar to a transfer of property at death, which is the essence of the Federal Estate Tax.  This inclusion causes the tax basis to increase from $100,000 to $300,000. However, since the homestead property was conveyed during Mrs. Kellogg’s life to an Irrevocable Trust without Mrs. Kellogg’s right to revoke it as would have been the case of a transfer to a Revocable Trust, Mrs. Kellogg made an inter-vivos and not a death time transfer of her homestead. Thus, under our solution, no judicial determination is required to determine homestead with a parallel probate proceeding because Mrs. Kellogg did not own or deem to own the homestead at her death.

Finally, Mrs. Kellogg could have retained her homestead real estate tax exemption by reapplying for it.

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