New Estate Planning Options for Florida Snowbirds
florida's Favorable Tax System is one Incentive for a New England Retiree to Make the sunshine state Home
The State of Florida has seen tremendous growth as its population has increased by almost 335,000 per year from 2000 to 2006. At the current pace, it may swell by 36% from 2000 to 2025. Included in this demographic is an ever-growing number of New Englanders migrating south either on a permanent or temporary basis.
Apart from the obvious climate differences, the favorable income and estate tax regime of Florida compared to Rhode Island and Massachusetts has created an even greater incentive for "snowbird" retirees to make Florida their legal home.
Florida imposes no estate tax, and the federal tax does not currently apply to taxable estates under $5 million. In contrast, the estate tax thresholds for Massachusetts and Rhode Island are currently $1 million and $892,865, respectively. Although a change of residence can be a difficult decision involving severing ties from northern roots, these differing tax policies are the genesis for valuable planning opportunities for those who split their time between Florida and Rhode Island or Massachusetts.
The most recognizable of Florida's estate planning opportunities is its friendly homestead law. This law provides significant creditor protection for Florida residents by exempting the property from forced sale, with limited exceptions for payment of taxes and assessments, purchasing obligations, or certain other obligations related to the realty. Furthermore, the courts are reluctant to impose an equitable lien against proceeds a debtor-homeowner invests in the homestead property, unless it is clear the money was obtained fraudulently or through egregious conduct.
One of the most commonly used estate planning techniques is to place the principal residence in a revocable trust for probate avoidance purposes. However, Florida attorneys were sent into a tailspin in 2001 due to a decision by the Florida Bankruptcy Court that said real estate owned by a revocable trust does not qualify for the homestead exemption because the law states a "natural person" must own the real estate.
Despite many commentators expressing their disagreement, lawyers were forced to rethink the effectiveness of this technique as it applied to the largest assets of most clients. Fortunately, recent court decisions, most notably the 2006 case Engelke v. Estate of Engelke, are moving away from this position stating that the grantor's ability to freely revoke the trust at any time is essentially the same as owning the residence individually.
Establishing residency in Florida will also help reduce the property taxes imposed on real estate. Because Florida does not have income or estate taxes, the State derives a significant amount of its income from sales and property taxes. In 1998, the Constitution of Florida was amended to limit the increase in real property assessments for residents. As a result, any increase in the assessed value of the homestead property is limited to the lower of (1) three percent of the assessed value from the prior year or (2) the percentage change in the consumer price index.
This favorable treatment is also available if the home is placed in an irrevocable trust, as long as the individual retains certain rights and responsibilities such as the right to occupy. Therefore, it is possible to structure the trust so that the individual has made a completed transfer for Medicaid purpose while retaining eligibility for the favorable limitations on increased tax assessments. This technique is effective when the client is likely to return to Rhode Island or Massachusetts if long-term care is required, and thus making the out-of-state property a non-countable asset otherwise.
AVOIDING ESTATE TAX ON SUMMER HOME
The Rhode Island and Massachusetts estate tax on individuals with estates exceeding certain threshold amounts applies to property located in the particular state. Therefore, if an individual dies a resident of Rhode Island owning only Rhode Island real estate and intangible property (e.g. cash and investment accounts) of $1 million, the entire amount is included in the estate for Rhode Island estate tax purposes.
The dilemma arises for the snowbird who dies owning property in multiple jurisdictions. If the individual is a Rhode Island or Massachusetts resident with a winter home in Florida, then both states will still impose their tax on the entire estate, including the Florida property. Although the estate is usually given a proportionate credit for taxes paid to another state, no reduction is available in this case because Florida imposes no estate tax.
How about the decedent who establishes residency in Florida but still owns a summer home in Rhode Island or Massachusetts? Rhode Island and Massachusetts will look to impose a tax on any property located in its state if the estate exceeds the threshold amount. Therefore, in the example above, if the individual was a Florida resident with a $1 million estate and a second home in Rhode Island worth $300,000, the decedent would be subject to estate tax because of the situs of the second home. The fact that the value of the real estate is below the threshold amount is irrelevant because the tax is calculated proportionately
CONVERTING REAL PROPERTY TO INTANGIBLE PROPERTY
One way to avoid this predicament for the Florida resident is to convert the real property into intangible property. This is achieved by transferring the out-of-state property to a Florida limited liability company, S-corporation or family limited partnership. As a result, the individual no longer owns an interest in real property, but rather an intangible membership/partnership interest or stock.
This technique is even more inviting to the Florida resident after the recent repeal of the intangible personal property tax effective January 1, 2007. That tax applied to the January 1st fair market value of intangible personal property (e.g. stocks, bonds, mutual funds, money market funds) owned by a Florida resident with exemptions for certain assets, most notably cash and retirement accounts.
But, given an exemption amount of $250,000 for individuals ($500,000 for married couples) and the ability to avoid the tax by placing the assets in specially structured trusts, the effectiveness of the tax was limited. Note that if the property generates income, there would be tax consequences in that state. But, at death, the only real estate owned by the individual will be located in Florida where no estate tax will be imposed. Given the appreciation of real estate in Rhode Island and Massachusetts over the past five years, this technique can provide a significant tax saving in light of the relatively low filing thresholds.
The states may look to address this perceived loophole by imposing a business purpose requirement to disregard the structured entities that hold solely vacation property. Therefore, business formalities should be closely observed when formulating these transactions. For instance, because single-member LLCs are taxed as disregarded entities, an argument exists that the real estate is owned by the decedent directly for tax purposes. It is advisable to create multimember entities to avoid this possible outcome.
Native New Englanders tend to have strong emotional ties to their region. Some simply refuse to change residency, regardless of the potential savings. But as the migratory population continues to increase, advising snowbirds to extend their stay in Florida could be the most effective advice of all in the current tax climate.
*Originally Published in Rhode Island Lawyers Weekly, June 25, 2007 and updated February 2012.