A favorite slogan of Estate Planners is “Avoid probate by using a living trust.” But why is that so important, and how does that technique actually work?
Probate is a judicial procedure for transferring assets from a deceased person to the beneficiaries. Being a courtroom process, it entails public disclosure and long delays. The primary reason to avoid probate is the California statutory minimum fee, for both the executor and the executor’s attorney. Those fees together add up to about 4% of the estate.
It’s critical to know that the probate fees are computed on the gross estate, before any liabilities. For example, let’s say that the deceased person owned a house worth $500,000, with a mortgage of $400,000, meaning that the equity is $100,000. The statutory fees of 4% are computed on the gross value of $500,000, so the fees are $20,000. That amount is exorbitant for drafting and recording a two-page deed. Compared to the equity of $100,000, that is a 20% fee, which is simply outrageous. That’s why estate planners emphasize avoiding probate. When property is transferred through a trust, probate does not apply.
First the property has to be retitled into the living trust. For a married couple, I often see that their house is titled as owned by “husband and wife as joint tenants.” Joint tenancy means that when one person dies, the whole property is inherited instantly by the other joint tenant. That is a one-time method to avoid probate. But for income tax purposes, it is not as good as community property.
In this situation, I prepare two deeds. The first one converts the house from joint tenancy to community property. Then the second one transfers the house to the Trustees of the living trust. Using two deeds makes it clear that the house is still community property while owned by the Trust — to get the best income tax treatment while avoiding probate.
This technique requires use of a sophisticated tool – the Post-It, to mark the deeds “File First” and “File Second.”