Wills and Trusts
By Saghir Aslam
(The following information is provided solely to educate the Muslim community about investing and financial planning. It is hoped that the ummah will benefit from this effort through greater financial empowerment, enabling the community to live in security and dignity and fulfill their religious and moral obligations towards charitable activities)
Many of you have heard me emphasizing the need for each and everyone to have a will. I have discussed this in depth in many seminars and in formal and informal gatherings as well. It is our Islamic duty to create a will to secure our future. It is more important to have a will in this great land of opportunity as here we do not have the Islamic Law of Inheritance.
Before I continue further, let me reiterate what has been said many times over, I am not an attorney, nor an expert on estate planning. I am simply sharing the information I have learned with you so you can find further professional help regarding this matter.
Do you own a valuable house? Are you likely to leave an estate large enough to be subject to federal estate tax?
If so, placing your house in a qualified personal residence trust (QPRT) can cut the eventual tax bite.
Here’s how it works: You create an irrevocable trust for a specified number of years, placing your house in the trust while retaining the right to live there.
Because your gift to the trust is a gift of what the Internal Revenue Service calls a “future interest,” it does not qualify for the annual gift tax exclusion of $10,000 per person.
But it does qualify for a discount, based on your age and the length of the trust. That discount is key to cutting estate taxes.
Let’s say you own a house valued at $400,000. Giving it outright to your children would mean using up a substantial portion of the $675,000 total you currently can give away without any of it being eaten by gift or estate taxes.
Give the house to a QPRT instead, reserving the right to use it for a term of 10 years. The taxable value of the gift could be as little as $120,000.
Transfers of jointly held property are complicated. I suggest changing the form of ownership from joint ownership to tenants in common. Under this arrangement, the husband and wife each own half the house and can place the halves in two separate trusts.
The value is reduced first simply by dividing the ownership. For the sake of a rough illustration, suppose that reduction is 15% of its value. Half a house is worth less than a fractional interest in the whole.
After marking down the value of both halves by 15%, each trust holds $170,000. Then the discounted value of each trust is calculated, based on current federal interest rates.
In this example, a 10-year trust where both spouses are age 65 results in a combined taxable gift for the couple of about $120,000. As a result, you took a $400,000 house out of your estate for a song.
Alternatively, if you want to avoid the complications of joint ownership put the house in the name of the younger, healthier spouse. That requires only one trust instead of two. The younger spouse is the one who establishes the trust.
The longer term of the trust, the larger the discount. But don’t be greedy: You must outlive the trust or the full value or the house goes back into your taxable estate.
Look at your life expectancy and your family history. A healthy 75-year old whose parents lived past 90 might consider a 10-year trust. A 55-year old whose parents both died at 60 probably should not set up a 15-year trust.
Note, too, that if the house is sold before the trust terminates, the full $500,000 exclusion from capital gains taxes for a married couple or $250,000 for a single taxpayer can be claimed. If it is sold afterward, the gain is taxable. This may be a downside to the QPRT, but it must be compared with the considerable estate tax savings likely to result if the homeowner outlives the term of the trust.
Also, the technique works best when there is no mortgage on the property. For example, you might be required to seek your lender’s consent for the trust. In most cases (a mortgage) is not an issue since the best candidate is well-to-do and getting on in years, and is not likely to have a mortgage.
In fact, the classic scenario for using this technique is a widow or widower who has an estate over $1 million and is afraid to give away stocks because he or she is living on them.
Giving the house away instead, by putting it in trust, creates huge benefits through discounted values.
The exclusion from gift and estate taxes-now $675,000-is scheduled to rise gradually until it reaches $1 million in 2006. But the house is also likely to appreciate in value, with all of the future appreciation removed from your estate once the house is held in trust.
If a QPRT appeals to you, act quickly, because there could be talk of repeal.
Get in while the getting is good. But first seek competent professional advice and run the numbers to be sure a QPRT is right for you.
Let me repeat what I have said many times; please consult your attorney or estate planner first. Different people might have different cases and must discuss each case separately with a reputable professional consultant. May Allah (SWT) help all of us in planning for the well being of our family for this life and in the hereafter.
(Saghir A. Aslam only explains strategies and formulas that he has been using. He is merely providing information, and NO ADVICE is given. Mr. Aslam does not endorse or recommend any broker, brokerage firm, or any investment at all, or does he suggest that anyone will earn a profit when or if they purchase stocks, bonds or any other investments. All stocks or investment vehicles mentioned are for illustrative purposes only. Mr. Aslam is not an attorney, accountant, real estate broker, stockbroker, investment advisor, or certified financial planner. Mr. Aslam does not have anything for sale)