Avoiding Capital Gains Tax with a Revocable Living Trust

When planning your estate in Florida, understanding how your assets, like your home, pass to your beneficiaries is crucial. A common question is whether a beneficiary, such as a daughter, will face capital gains tax when inheriting a home through a revocable living trust. This article explains how a revocable living trust works, the benefits of a step-up in basis, and why your daughter may avoid capital gains tax upon inheriting and selling your property.

What Is a Revocable Living Trust?

A revocable living trust is a legal entity you create to hold assets, such as real estate, during your lifetime. As the grantor (the person who creates the trust), you can manage, modify, or revoke the trust while you're alive. Upon your passing, the assets in the trust, like your home, transfer directly to your named beneficiaries—such as your daughter—without going through probate, the often time-consuming and costly court process.

Why Use a Revocable Living Trust?

• Avoid Probate: Unlike a will or standard inheritance under Florida law, a revocable living trust ensures your property passes to your beneficiary without the need for probate.

• Flexibility: You can change or revoke the trust during your lifetime, giving you control over your assets.

• Step-Up in Basis: A key tax advantage, explained below, that can minimize or eliminate capital gains tax for your beneficiary.

  
  

Understanding Capital Gains Tax and the Step-Up in Basis

When your daughter inherits your home through a revocable living trust, she benefits from a step-up in basis, a critical tax concept. Here’s how it works:

• What Is a Step-Up in Basis? The basis of a property is typically what you paid for it. However, when property is inherited—whether through a revocable living trust, a lady bird deed, or probate—the IRS allows the beneficiary to “step up” the basis to the fair market value (FMV) of the property on the date of the grantor’s death.

• Why It Matters: When your daughter sells the inherited property, capital gains tax is calculated based on the difference between the sale price and her basis. If she sells the property soon after inheriting it (typically within 6 months to a year), the sale price is likely to be close to the FMV at the time of your death, meaning little to no taxable gain.

  
  

Example Scenario

Let’s say you originally purchased your home for $200,000, but at the time of your passing, its fair market value is $900,000. If your daughter inherits the home through your revocable living trust:

• Her basis in the property is “stepped up” to $900,000 (the FMV at your death).

• If she sells the home within 6 months to a year for $910,000, her taxable gain is only $10,000 ($910,000 sale price - $900,000 basis).

• In many cases, if the sale price is equal to or less than the FMV at the time of inheritance, there’s no capital gains tax because there’s no gain.

This step-up in basis applies whether the property is inherited through a revocable living trust, a lady bird deed, or even probate. However, using a trust or lady bird deed avoids the probate process, saving time and money.

Revocable Living Trust vs. Lady Bird Deed vs. Probate

• Revocable Living Trust: The property is transferred into the trust during your lifetime, and the trust becomes the owner. Upon your death, the property passes to your beneficiary (e.g., your daughter) without probate, and she receives the step-up in basis.

• Lady Bird Deed: Also known as an enhanced life estate deed, this allows you to retain control of the property during your lifetime and automatically transfer it to your beneficiary upon your death, bypassing probate and providing a step-up in basis.

• Probate: If your home is not in a trust or covered by a lady bird deed, it will pass through Florida’s probate process, which can be costly and time-consuming. However, the step-up in basis still applies.

By using a revocable living trust or lady bird deed, you ensure a smoother transfer of your home to your daughter while maintaining the tax benefits of the step-up in basis.

When Might Capital Gains Tax Apply?

If your daughter holds onto the inherited property for several years before selling, the property’s value may appreciate beyond the stepped-up basis (the FMV at your death). In this case, she could face capital gains tax on the difference between the sale price and the stepped-up basis. For example:

• If the home’s FMV at your death is $900,000 (her basis), and she sells it years later for $1,200,000, she would owe capital gains tax on the $300,000 gain.

• To minimize or avoid capital gains tax, selling the property within 6 months to a year of inheritance is ideal, as the sale price is likely to align closely with the FMV.

  
  

Why Choose a Revocable Living Trust in Florida?

A revocable living trust is a powerful estate planning tool for Florida residents. Here’s why it’s a smart choice:

1. Avoids Probate: Saves your family time, money, and stress.

2. Tax Benefits: Ensures your beneficiary receives a step-up in basis, potentially eliminating capital gains tax on the sale of inherited property.

3. Control and Flexibility: You can modify or revoke the trust as needed during your lifetime.

4. Privacy: Unlike probate, which is a public process, a trust keeps your estate details private.

   
   

Get Expert Estate Planning Advice in Florida

If you’re considering a revocable living trust, lady bird deed, or other estate planning options in Florida, consult with an experienced attorney to ensure your assets are protected and your wishes are carried out. AtCause Law Office, our non-stuffy attorneys are here to answer your questions about trusts, probate, and capital gains tax. Contact us today for personalized guidance tailored to your needs.

Disclaimer: This article is for informational purposes only and does not constitute legal advice. Consult a qualified attorney for advice specific to your situation.