Estate Planning for Real Estate: How to Pass Properties to Your Heirs

You spent decades building a [real estate portfolio](/blog/how-to-finance-multiple-properties). Maybe it's a single family home where you raised your kids. Maybe it's seven rental properties generating $5,000 a month. Either way, what happens to these properties when you die isn't a theoretical question — it's a practical one that affects your family's financial future.

Without proper planning, real estate transfers at death trigger probate proceedings (expensive, slow, public), potential tax bills (federal estate tax, state inheritance tax, capital gains), family disputes (who gets what, who manages what), and forced sales (to pay taxes or settle disagreements).

With proper planning, your properties transfer smoothly, taxes are minimized or eliminated, your wishes are respected, and your heirs receive maximum value.

This guide covers the strategies that actually work — not the generic advice you find in estate planning brochures, but the specific approaches that real estate owners need to understand.

The Stepped-Up Basis: The Single Most Valuable Tax Benefit in Real Estate

Before discussing transfer strategies, you need to understand the stepped-up basis — because it affects every decision you make.

When you die, your heirs inherit your property at its current fair market value, not what you originally paid. This is called a "stepped-up basis."

Example: You bought a rental property in 2005 for $180,000. It's now worth $420,000. If you sold it today, you'd owe capital gains tax on $240,000 in appreciation (plus depreciation recapture — more on that below). At 15-20% federal capital gains rates, that's $36,000-$48,000 in taxes.

If you hold the property until death, your heirs inherit it with a basis of $420,000. They could sell it immediately for $420,000 and owe zero capital gains tax. The $240,000 gain disappears entirely.

For rental properties, this is even more valuable because of depreciation recapture. Over the years, you've deducted depreciation against your rental income. When you sell, the IRS "recaptures" those deductions at a 25% tax rate. If you've claimed $100,000 in depreciation, that's $25,000 in recapture tax — on top of capital gains.

At death, the stepped-up basis eliminates both the capital gains and the depreciation recapture. On a portfolio of rental properties with decades of appreciation and depreciation, this can save heirs hundreds of thousands of dollars.

The implication: Never sell highly appreciated real estate late in life if you can avoid it. Hold it, pass it at death, and let the stepped-up basis eliminate the tax burden. This principle should drive every estate planning decision involving real estate.

Transfer Strategy 1: Revocable Living Trust

A revocable living trust is the gold standard for passing real estate to heirs. It's the single most recommended tool by estate planning attorneys for property owners, and for good reason.

How It Works

You create a trust during your lifetime. You transfer title of your properties from your personal name into the trust (e.g., from "John and Mary Smith" to "The John and Mary Smith Revocable Trust"). You name yourself as the trustee (manager) and your heirs as beneficiaries. You designate a successor trustee who takes over when you die or become incapacitated.

While you're alive, nothing changes. You manage the properties exactly as before. You collect rent, pay expenses, buy and sell — all in the trust's name. You pay taxes on trust income on your personal return (it's a "grantor trust"). You can modify or revoke the trust at any time.

When you die, the successor trustee distributes assets according to the trust terms. No probate. No court involvement. No public record.

Why It's Essential for Real Estate

Probate avoidance. Real estate that passes through a will must go through probate — a court-supervised process that takes 6-18 months (or years in contested cases), costs 3-7% of the estate value in legal and court fees, and is entirely public. Every nosy neighbor can look up what your properties are worth and who inherited them.

A trust avoids all of this. Properties transfer to heirs within weeks, not months.

Multi-state probate avoidance. If you own property in three states, your estate goes through probate in each state where you own property. That's three separate probate proceedings with three sets of attorneys. A trust eliminates all of them.

Incapacity planning. If you become mentally incapacitated (dementia, stroke, severe illness), your successor trustee immediately takes over managing your properties — paying taxes, collecting rent, handling repairs. Without a trust, your family must petition a court for conservatorship, which is expensive, slow, and humiliating.

Privacy. Trust distributions are private. Wills become public record. For families with significant real estate holdings, privacy has real value.

Setting Up a Trust for Real Estate

1. Hire an estate planning attorney. This is not a DIY project. A properly drafted trust for real estate owners costs $2,000-$5,000 — a fraction of what probate would cost. Online trust services miss critical real estate provisions.

2. Fund the trust. This is the step most people skip, rendering the trust useless. You must actually deed your properties into the trust. Your attorney or a title company prepares new deeds transferring each property from your name to the trust name. This is a simple filing but must be done for every property.

3. Update insurance and lender notifications. Notify your insurance company that the property is now held in a trust. Most policies cover trust-held properties without issue. If you have mortgages, check the loan documents — most modern mortgages allow trust transfers without triggering the due-on-sale clause, but older loans may differ.

4. Maintain the trust. When you buy new properties, take title in the trust's name. When you refinance, ensure the trust remains on title (you may need to temporarily deed the property back to your personal name for the refinance, then re-deed it to the trust after closing).

Trust Terms for Real Estate

Your trust should address:

• Who inherits each property (specific bequests: "Property A goes to Child 1, Property B goes to Child 2")
• Whether properties should be sold or kept ("The trustee shall distribute Property A in kind to Child 1" vs. "The trustee shall sell all real property and distribute proceeds equally")
• Management during transition ("The trustee shall continue professional [property management](/blog/property-management-complete-guide) for 12 months following the grantor's death to ensure continuity")
• Buyout provisions ("If one beneficiary wishes to retain a property, they may purchase the other beneficiaries' shares at fair market value as determined by independent appraisal")
• Distribution timing ("Income properties shall continue to generate income for the trust for 6 months following death, with net income distributed equally to beneficiaries, before properties are distributed or sold")

Transfer Strategy 2: LLC + Trust Combination

For rental property portfolios, combining LLCs with a trust provides both [asset protection](/blog/real-estate-llc-guide) during your lifetime and smooth estate transfer at death.

How It Works

Each rental property (or group of properties) is held in a separate LLC. You own the LLC membership interests. Your revocable trust owns those LLC membership interests.

The structure looks like:

You → Revocable Trust → LLC(s) → Properties

Why This Matters

Asset protection. If a tenant sues over a property in LLC #1, only the assets in LLC #1 are at risk — not your personal assets, not your other properties. Without LLC separation, a single lawsuit can threaten your entire portfolio.

Simplified transfer. Instead of deeding individual properties at death, the trust simply distributes LLC membership interests. No new deeds needed, no title changes, no transfer taxes in most states.

Operating continuity. The LLC has its own bank accounts, leases, and vendor contracts. When you die, the successor trustee steps into management of the LLC without disrupting operations. Tenants keep paying rent to the same LLC. Nothing changes from their perspective.

Costs and Complexity

Each LLC has formation costs ($100-$800 depending on state), annual filing requirements ($0-$800/year depending on state), a separate bank account, and its own bookkeeping. For a large portfolio, the cost is justified. For a single rental property, it may be overkill — discuss with your attorney.

Some states are hostile to single-member LLCs for asset protection. Wyoming and Nevada offer stronger LLC protections than California or New York. You don't need to form the LLC where the property is located, but you'll need to register as a foreign LLC in that state.

Transfer Strategy 3: Tenancy and Titling Strategies

For a primary residence or a small number of properties, simpler titling strategies may suffice.

[Joint Tenancy with Right of Survivorship](/blog/joint-tenancy-vs-tenants-in-common) (JTWROS)

When one joint tenant dies, their interest automatically passes to the surviving tenant(s). No probate needed.

Pros: Simple, free, immediate transfer.

Cons: No control over ultimate distribution (the surviving owner can do whatever they want with the property), potential gift tax implications if adding a non-spouse, loss of full stepped-up basis on the first spouse's death (only 50% of the property gets a step-up — though in community property states, 100% gets a step-up).

Tenancy by the Entirety

Available to married couples in about 25 states. Similar to JTWROS but with additional creditor protection — one spouse's creditors can't force a sale of the property.

Transfer on Death (TOD) Deeds

Available in about 30 states (including California, Colorado, Ohio, Texas, and others). A TOD deed names a beneficiary who automatically inherits the property at your death, avoiding probate. You retain full control during your lifetime and can revoke or change the beneficiary at any time.

Pros: Simple, inexpensive ($50-$200 to prepare and record), avoids probate.

Cons: No incapacity protection (unlike a trust), limited in the terms you can attach, may create conflicts if you also have a will or trust with different instructions, not available in all states.

TOD deeds work well as a supplementary tool for simple situations — a single primary residence passing to one child, for example. For multi-property portfolios, a trust is still superior.

Transfer Strategy 4: Irrevocable Trusts for Estate Tax Planning

For estates exceeding the federal estate tax exemption ($13.61 million per individual in 2025, or $27.22 million per married couple), irrevocable trusts become necessary to minimize estate taxes.

The Estate Tax Landscape

The current exemption is historically high — a result of the 2017 Tax Cuts and Jobs Act. This provision is scheduled to sunset after 2025, potentially cutting the exemption roughly in half (to approximately $7 million per individual). If you have a real estate portfolio worth $5-$15 million, estate tax planning is urgent.

Federal estate tax rates on amounts above the exemption start at 18% and climb to 40%. On a $20 million estate with a $13.6 million exemption, the tax on the excess $6.4 million is approximately $2.3 million.

Several states impose their own estate or inheritance taxes with lower exemptions. Oregon's exemption is just $1 million. Massachusetts: $2 million. New York: $6.94 million. Even if your estate is below the federal threshold, state estate taxes can be significant.

Qualified Personal Residence Trust (QPRT)

A QPRT transfers your home to an irrevocable trust while you retain the right to live in it for a specified term (say, 15 years). At the end of the term, the property passes to your heirs. The gift tax value is discounted because your heirs don't receive the property for 15 years — the longer the term, the larger the discount.

A $1 million home transferred via a 15-year QPRT by a 65-year-old might have a taxable gift value of only $350,000-$450,000, effectively removing $550,000-$650,000 from the taxable estate.

Risk: If you die before the term ends, the property reverts to your estate and the tax benefit is lost. The strategy works best when you're healthy and the term is realistic.

Grantor Retained Annuity Trust (GRAT)

Transfers [property appreciation](/blog/best-cities-for-appreciation-2026) to heirs with minimal gift tax. You contribute property to a GRAT and receive annuity payments for a set term. At the end, remaining assets pass to beneficiaries. If the property appreciates faster than the IRS-prescribed interest rate (called the Section 7520 rate), the excess passes tax-free.

Family Limited Partnership (FLP) or Family LLC

You contribute properties to an FLP or LLC, retain a controlling interest (general partner or managing member), and gift limited partnership/membership interests to your heirs over time. The gifted interests qualify for valuation discounts (typically 20-35%) because they represent minority, non-controlling interests in an illiquid entity.

A $5 million real estate portfolio contributed to an FLP might allow you to gift interests valued at $3.25-$4 million for gift tax purposes — a $1-$1.75 million discount. Over time, you gift limited partnership interests to heirs using your annual gift tax exclusion ($18,000 per recipient in 2025) and/or your lifetime gift tax exemption.

Warning: The IRS scrutinizes FLPs aggressively. The entity must have legitimate business purposes beyond tax avoidance, operate with proper formalities, and maintain arm's-length transactions. Poorly structured FLPs get disallowed and can trigger penalties.

Practical Considerations for Real Estate Heirs

The "What Do We Do With This Property?" Problem

Inheriting a rental property is very different from inheriting stocks. Stocks sit in an account and generate dividends. A rental property needs management, maintenance, tenant relations, insurance, tax filing, and decision-making.

Before you die, create a comprehensive property information package for each property:

• Current lease terms and tenant contact information
• Property management company details (or self-management procedures)
• Mortgage information (lender, balance, payment schedule)
• Insurance policies (carrier, coverage amounts, renewal dates)
• Property tax details (amount, payment schedule, any exemptions)
• Maintenance vendor list (plumber, electrician, HVAC, handyman)
• Capital improvement history (roof age, HVAC age, water heater, etc.)
• Current rent roll and historical financials
• Any pending issues (lease renewals, planned repairs, code violations)

Store this in a fireproof safe or with your attorney. Update annually.

Equal vs. Equitable Distribution

You have three rental properties worth $300,000, $400,000, and $500,000, and three children. Equal distribution doesn't mean giving each child one property — that's inequitable. Options:

1. Sell all properties and split proceeds equally. Simplest and fairest, but triggers capital gains taxes (mitigated by stepped-up basis) and loses the income stream.

2. Distribute properties with equalizing payments. Child A gets the $500,000 property and pays $66,667 to each sibling from other inherited assets or the estate.

3. Create a trust that holds all properties. All three children are equal beneficiaries. The trustee manages properties and distributes net income equally. Properties are eventually sold and proceeds distributed when the trustee determines it's advantageous.

4. Ask your children what they want. Maybe one child wants to manage rental properties and two don't. Give the interested child the rentals and the others equivalent value in other assets. Matching assets to interest and capability prevents resentment and mismanagement.

The Co-Ownership Trap

Leaving a property to multiple heirs as co-owners is a recipe for disaster. One sibling wants to sell, another wants to keep it, and a third wants to live in it. Disagreements escalate to partition actions (court-ordered sales), which are expensive and destroy value.

Solutions:

• Use your trust to give clear instructions (sell, distribute, or designate one heir with buyout rights)
• Include a mediation clause before any heir can pursue legal action
• Appoint an independent trustee to make final decisions if heirs disagree
• Set a timeframe: "If beneficiaries cannot agree on disposition within 12 months, the trustee shall sell the property at fair market value"

Tax Strategies for Real Estate Estates

Portability of the Estate Tax Exemption

If your spouse dies first and doesn't use their full estate tax exemption, you can "port" their unused exemption to yourself — effectively doubling your exemption. But this requires filing a federal estate tax return (Form 706) for the deceased spouse within 9 months of death, even if no tax is owed.

Many families skip this filing because no tax is due. That's a potentially multi-million-dollar mistake. Always file Form 706 for a deceased spouse to preserve portability.

Installment Sale to an Intentionally Defective Grantor Trust (IDGT)

An advanced strategy for high-value portfolios: sell properties to an irrevocable trust you've established (the IDGT) in exchange for a promissory note. Because the trust is a "grantor trust" for income tax purposes, the sale doesn't trigger capital gains (you're selling to yourself, essentially). But for estate tax purposes, the property is no longer in your estate.

The trust makes payments on the note from rental income. When you die, the note is an asset of your estate, but the properties — and all future appreciation — are outside your estate.

This works best for rapidly appreciating properties or portfolios generating strong cash flow.

Charitable Remainder Trust (CRT)

If you're charitably inclined, a CRT lets you:

1. Transfer property to the trust
2. Receive an income stream for life (or a term of up to 20 years)
3. Get an immediate income tax deduction for the charitable remainder
4. Avoid capital gains on the sale of the property (the trust sells it)
5. The remaining assets pass to your designated charity at your death

The trade-off: your heirs don't inherit the property or its value. But you receive more income during your lifetime and reduce your taxable estate.

The Estate Planning Timeline

In Your 50s

• Create or update your will and power of attorney
• Establish a revocable living trust and fund it with your properties
• Organize property documentation
• Review beneficiary designations on all accounts
• Consider LLC structures for rental properties

In Your 60s

• Review and update your trust as family circumstances change (marriages, divorces, grandchildren)
• Begin conversations with heirs about your plans
• Evaluate whether advanced strategies (FLP, GRAT, QPRT) make sense given estate size
• Ensure all properties are properly titled in your trust
• File portability election if spouse has passed

In Your 70s

• Finalize distribution plans
• Ensure successor trustee is capable and willing
• Consider whether properties should be sold or transferred during your lifetime vs. at death
• Create the property information packages for each holding
• Update estate plan for any changes in tax law

In Your 80s+

• Simplify where possible — consolidate properties, pay off remaining mortgages
• Ensure your successor trustee has full access to all property information
• Confirm that all titling is correct (properties in trust, beneficiaries current)
• Consider whether a professional trustee (bank trust department, trust company) should replace family members

FAQs

Do I need a trust if I only own one property — my home?

It's still recommended in most states. Probate on a single property can cost $5,000-$15,000+ and take 6-12 months. A trust costs $2,000-$5,000 to establish and avoids probate entirely. The math favors the trust. The exception: states with simplified probate procedures for small estates and states offering TOD deeds, where the cost-benefit is closer.

What's the difference between the estate tax and inheritance tax?

Estate tax is paid by the estate before distribution. Inheritance tax is paid by the person receiving the inheritance. Six states impose inheritance taxes: Iowa (being phased out), Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Maryland is the only state that imposes both. Rates and exemptions vary — in Pennsylvania, children pay 4.5% on inherited property value; siblings pay 12%; unrelated heirs pay 15%.

Can I just add my child to my property's deed to avoid probate?

You can, but you shouldn't in most cases. Adding a child as a co-owner: (1) may trigger gift taxes, (2) eliminates the stepped-up basis on their half (they get your original cost basis, not the current value), (3) exposes the property to their creditors, lawsuits, and divorce proceedings, and (4) can create capital gains taxes when they eventually sell. A trust accomplishes probate avoidance without any of these downsides.

How does the stepped-up basis work for community property vs. common law states?

In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin), both halves of community property get a stepped-up basis when one spouse dies — even though only one spouse passed away. In common law states, only the deceased spouse's share gets the step-up. This is a significant advantage for couples in community property states with highly appreciated real estate.

What happens to my rental property debt when I die?

Mortgages don't disappear at death. Your heirs inherit the property subject to the existing mortgage. They can: (1) continue making payments and keep the property, (2) refinance the mortgage in their name, (3) sell the property and pay off the mortgage from proceeds, or (4) let the lender foreclose if the property is underwater. Federal law (Garn-St. Germain Act) prevents lenders from calling the loan due solely because the property transferred to an heir.

Should I gift properties to my children during my lifetime?

Usually not. Gifting eliminates the stepped-up basis — your child inherits your original cost basis, meaning they'll owe capital gains on all the appreciation when they sell. Gifting a property you bought for $100,000 that's now worth $400,000 saddles your child with $300,000 in future taxable gains. If you hold it until death, the stepped-up basis eliminates those gains. The only exceptions: when your estate exceeds the estate tax exemption and the tax savings from removing the property outweigh the lost step-up, or when you're using advanced strategies like GRATs or FLPs with professional guidance.

How often should I update my estate plan?

Review your estate plan every 3-5 years, and update it immediately after any major life event: marriage, divorce, death of a beneficiary or trustee, birth of grandchildren, significant change in property values or portfolio composition, or changes in tax law. Also verify that all properties acquired since the last update are properly titled in your trust.

The Bottom Line

Real estate is one of the best assets to build generational wealth — but only if you plan for the transfer. Without proper estate planning, the properties you spent a lifetime acquiring can become a source of family conflict, tax liability, and lost value.

The core principles are simple:

1. Hold appreciated property until death to capture the stepped-up basis
2. Use a revocable living trust to avoid probate and ensure smooth transfer
3. Communicate your plans to your heirs before they become surprises
4. Organize your property documentation so your successor trustee can operate immediately
5. Get professional help — estate planning for real estate is too consequential for DIY

The best time to set up your estate plan was when you bought your first property. The second-best time is today.

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