Avoiding probate sounds like a great idea, so why doesn’t everyone structure their affairs to avoid probate? Well before we jump in to that topic we need to define probate. Probate is the legal proceeding through which assets will be transferred in accordance with a will or intestacy laws. Sound familiar, well it should because I defined probate in my previous post on documents in a simple estate plan. Key to all of this is the definition of the assets in a probate proceeding, known as probate assets. Probate assets are those assets that are titled in your name only and do not pass automatically. Assets that have beneficiary designations will pass by their own terms automatically and are therefore not probate assets. Trusts can operate in the same way as re-titling assets with beneficiary designations, this will be discussed later in the post.
How to avoid Probate
Ok, so we know what proabte and probate assets are, so how can you avoid probate? One way to completely avoid probate is to title all of your assets so they have a beneficiary designation and will therefor pass automatically to the beneficiary upon your death. For example if your assets consisted of a parcel of real estate, a life insurace policy, a 401k plan and various personal items (valued less than $20,000 at date of death) it would be possible to avoid probate by: Titling the real estate in a Joint Tenancy with Rights of Surviorship, designating a beneficiary (other than your estate) on the life insurance and 401k plan. At your death all of these assets would pass automatically outside the probate process and your descendants could collect the personal items through an affidavit filed with a certified copy of the death certificate.
Sounds great doesn’t it? Not so fast, the problems with a plan to avoid probate simply through titling assets are numerous. For starters this plan assumes that all descendants will agree as to whom will collect the property and how it will get split up. Maybe Johnny and Tommy both want dad’s old pick-up truck and Suzie and Mary want the family bible. Family arguments over the distribution of property are more common than many people believe. If the family members cannot come to an agreement over the distribution of the assets they could end up in probate court with an expensive fight on their hands.
Beyond the family problems, titling assets in joint ownership will not take advantage of a “step up in basis” for the assets. Basis is the original or acquisitonal value of an asset. When an asset is sold gain, for tax purposes, is calculated by subtracting the basis from the sale price. For example, imagine that mom owned a piece of real estate that she purchased for $10,000. If she were to sell it for $40,000 she would have a gain of $30,000 ($40,000 – $10,000). If mom titled that asset as a joint tenancy with son and mom dies, the son gets the property with a basis of $10,000. This is known as a carryover basis. Under the current tax law when property is inhereted the person receiving the property gets the property with a basis equal to the fair market value of the property, known as a stepped up basis. So if the son inhereted the property he would have a basis of $40,000. For our example we are assuming that the property is worth $40,000. If son were to sell the property for $40,000 he would have a gain of $0 ($40,000 in basis – $40,000 sales price = $0). Since there is no tax gain the son would not have to pay taxes on the sale!
A better way to avoid Probate
So we’ve seen one way to avoid probate, a process that is fraught with pitfalls, but other options exist and they are not complicated. The other way to avoid probae in Minnesota is through the use of trusts. Trusts transfer property outside the probate process because the assets in the trust are titled in the name of the trust. When a trust is created the assets used to fund the trust are re-titled and the trust becomes the owner of those assets. Of course cash can be used to fund a trust, usually done by opening a bank account in the name of the trust and transfering money into the account.
Using our previous example mom would set up a trust or trusts with the help of an estate planning attorney to take care of her assets. This brings us to a choice for mom, she can either create a revocable trust or a testamentary trust. This topic is beyond the scope of this post and will be handled in future posts. Regardless of the choice of trusts mom will be able to spell out her wishes as to how the assets will be handled. The kids won’t have to fight over who gets what as mom would direct to whom each asset will pass. But the downside is that the kids may not receive a step up in basis when they receive the property from the trust.
The ups and downs of avoiding probate
Avoiding probate has its pros and cons and we have only scratched the surface of the techniques and plans used to stay outside the probate process. The stakes can be high when attempting to avoid probate, you could be missing the opportunity for a huge step up in basis and therefore subject yourself to large tax obligations. Before you attempt to avoid probate or even try to decide if it is beneficial to you to avoid probate I encourage you to contact an estate planning attorney and have a meaningful discussion. If you would like to discuss your options with me I can be reached at james@jtandersonlaw.com, or head on over to the website of the Law Offices of James T. Anderson. I am always willing to sit down with people for a free one our consultation. And please remember this is only general information, it is not legal advice. Please seek legal advice from an attorney before attempting this on your own.
