In 2011 the estate tax is back after a one year temporary repeal, and the thing about it that can take a lot of people by surprise is the new exclusion amount. In 2009 the exclusion was $3.5 million, so if the total overall value of your estate did not exceed this number it was not subject to the estate tax. However, in 2011 this figure has been shrunk down to just $1 million, and the maximum rate of taxation is 55%. So if your next door neighbor died in 2009 with an estate worth exactly $3.5 million her heirs paid no estate tax at all. But if the neighbor across the street dies in 2011 with an estate worth the exact same $3.5 million, his heirs will get a bill from the IRS for $1.375 million.
The logic behind this is anybody’s guess, but the way that it impacts you and me is this: if your estate is worth more than a million dollars you would be well advised to re-situate your assets to avoid the estate tax. One way to do this is through the creation of a qualified personal residence trust. With these instruments you place your house in the trust and name your heirs as the beneficiaries. You can live in the home for a period of time that you prescribe when you draw up the trust agreement free of rent, but of course you do have to take care of maintenance costs and property taxes.
The value of the home has now been removed from the estate, but as a gift to the trust it is subject to the gift tax. However, the taxable value is reduced by your retained interest in the house so the true market value is not used by the IRS. If this amount turns out to be less that the $1 million lifetime gift tax exemption, no gift tax will be due on the transaction, and if your remaining assets aside from the home are valued at less than the $1 million estate tax exclusion, your heirs will escape estate tax liability as well