When Marie Moore asked me to be a guest columnist for the Last Word, I didn’t quite know what to say. I’ve been reading this column for years and have a deep appreciation for the contributions Marie has made to the RPTE Section and to the bar in general. She told me to write something a little mean and a little funny. Well … here goes.
The way you dispose of tangible personal property in your revocable trust is stupid. There, I said it.
I’m going to unpack that idea a little. For my real property friends, tangible personal property (TPP) is the physical stuff you own at the time of your death. That’s everything from your toothbrush to your wedding ring. Almost every last will and testament distributes TPP outright to the surviving spouse. That makes sense. It’s also standard for a revocable trust to have a matching provision, but when you stop and think about it, having this provision in a revocable trust does not make any sense at all.
There are only three ways a revocable trust could own TPP. First, the property passed to the trust as a result of the grantor’s death, most likely at the direction of a will. Second, the grantor transferred the property to the trust before dying. Third, and least likely, the grantor funded the trust with liquid assets, and the trustee used those funds to purchase the TPP. Each of these options involves a thoughtful choice by the grantor or an advisor to hold TPP in the name of the revocable trust. This ownership structure was created for a reason, so why unwind that structure after the grantor dies?
The most common reason for a revocable trust to own TPP is to avoid probating those assets. Distributing TPP to the surviving spouse simply doesn’t make sense. You are taking a probate-free asset and transferring it back into the probate estate of the surviving spouse!
Despite being included in virtually every estate plan I have ever read, distributing TPP from a revocable trust to the surviving spouse is the wrong choice. At a minimum it should not be the default choice for your model revocable trust. You’re probably asking what I think your model should say. TPP should pass to a trust for the benefit of the surviving spouse, since that is the simplest way for the surviving spouse to continue to use the property while avoiding probate of those assets at death. As for what kind of trust, I have two suggestions.
One option is to direct the TPP to the revocable trust of the surviving spouse. That should still qualify for a marital deduction because the revocable trust can easily be drafted to meet the requirements of a general power of appointment trust under IRC § 2056(b)(5). Because the assets went from one revocable trust to another, they won’t need to be probated on the first death, nor on the death of the surviving spouse.
A second option is to direct the TPP to a marital trust, such as an IRC § 2056(b)(7) qualified terminable interest property (QTIP) trust. Once again you will have a marital deduction on the death of the first spouse, and you will avoid probate on both deaths.
Both of these approaches will result in a step-up in basis on the death of the second spouse, although that is generally not a significant issue for TPP.
I tend to favor bequeathing assets to the revocable trust of the surviving spouse, since it’s always a little awkward to own TPP in an irrevocable trust. For example, if the property is owned through a QTIP trust, would it be covered by the homeowner’s policy of a surviving spouse? Technically, the trustee of the marital trust has an obligation to inventory the property and to approve of its disposition. For example, to throw away some used clothing a surviving spouse would need to obtain the trustee’s approval. Similarly, donating that property to charity is a hassle because the spouse must be the sole beneficiary of a marital trust. It must be formally distributed out to the spouse first.
In fairness, I’m reasonably sure that every revocable trust I ever drafted distributed TPP to the surviving spouse. Having reviewed thousands of trusts drafted by other firms, I can tell you this is an industry standard provision, but I’ve come to the conclusion it should not be. It’s stupid. Stop it.
Thanks for letting me borrow your soapbox, Marie. I feel much better now!