Dear Len & Rosie,
My mother died and left me her home and her personal property. Her home is worth about $450,000. I do not wish to inherit the house. Can I disclaim it and designate that the home will go to only one of my two daughters?
Chris
Dear Chris,
Disclaimers seem simple, but they are tricky. A disclaimer is a document that more or less says "Thank you very much, but I don't want this." A disclaimer has to be absolute. You cannot designate what will happen to your mother's home if you disclaim it. Instead, you will be treated as having died before your mother when it comes time to distribute the home from your mother's estate or trust.
This means that the terms of your mother's will or trust are still important. If her estate planning documents state that the home is to go to your favored daughter if you die first, than your plan will work. But if the gift of the home to you is by right of representation, then both of your daughters will inherit the home if you disclaim it.
There are other complications as well. If you disclaim the home and it passes to your daughter, it will be subject to a property tax reassessment under Proposition 13. Your daughter's property taxes will be based on the present value of your mother's home, rather than the old Prop. 13 protected assessment. However, if you inherit the home from your mother, and then you sell it or give it to your daughter, then both transfers are exempt from reassessment under the parent-to-child transfer rules enacted by Proposition 58.
Disclaimers have limitations. You must sign the disclaimer within nine months of your mother's date of death, and you cannot disclaim assets from which you have already received a benefit. For example, if your mother's home is rented out, and you have already received rental income, then it's too late to disclaim the home.
First you need to determine whether or not a disclaimer is possible, and whether or not it will do what you want. Then you need to decide between the property tax consequences to your daughter if you disclaim the home, against the gift and estate tax consequences to you if you inherit the home and simply give it to her. You should review your mother's estate plan with a trusts and estates attorney.
Len & Rosie
Dear Len & Rosie,
My home is my major asset. I had planned on leaving it to one individual upon my death, but that person recently passed out of my life. Now I would like it to be shared by eight or ten persons. As my home has a very low cost basis, I understand that my estate will have to pay capital gains taxes before it can distribute the remainder to my heirs. If I leave my home to all of them, either in joint tenancy or as tenants-in-common, I would imagine that it would make the sale of the property very difficult. There must be an elegant solution. What do you recommend?
Curtis
Dear Curtis,
Luckily, you have some common misconceptions about how capital gains tax will work after your death. It is not nearly as bad as you think. In fact, upon your death, your heirs may sell your home and pay no capital gains tax at all.
When you die, everything that you own will be subject to federal estate tax at a progressive tax rate that approaches 47%. Fortunately, each of us has a federal gift and estate tax unified credit that will pay the estate tax on the first $1,500,000 of your assets, if you die in 2005. The unified credit will increase under current tax law to protect $2,000,000 from estate tax in 2006, $3,500,000 in 2009, and an unlimited amount of assets in 2010. In 2011, the law repealing the estate tax will expire, and the amount protected from estate tax will fall back to $1,000,000.
Why are we talking about federal estate tax? The reason is that when you die, each asset you own that is subject to federal estate tax will get a "step-up" in cost basis equal to its value upon your date-of-death. Because the cost basis in your home will increase from its purchase price to its date-of-death value, your home can be sold upon your death and no capital gains tax will be due, unless the home increases in value between your death and the date it is eventually sold.
You are absolutely correct in that it would be a bad idea to leave the home directly to your heirs. It is very unlikely that so many people would want to continue to own the property together after your death, but if all of them cannot agree to sell the property, they may wind up suing one another in an action for partition to force a sale. Do not let that happen. Your estate plan should name one of your friends or relatives as the executor of your estate, or the successor trustee of your trust, and direct him or her to sell your home and divide the proceeds of its sale among your beneficiaries.
Len & Rosie
Dear Len & Rosie,
In 1998, my mother gift-deeded her home to all three of her children. She retained a life estate for herself. In 2003, my mother passed way. Will I have to pay capital gains tax for my share of the home when it's sold? Is it too late to have my mother's home assessed to reduce the capital gains tax due?
Nancy
Dear Nancy,
When you sell the home, the amount of tax due will be based on the difference between the sale price of the home and the home's cost basis. You have to pay tax on the profit earned because the home as gone up in value.
Fortunately, your mother gave you the home reserving a life estate for herself. When she owned the home, the cost basis was either the purchase price of the home or the value of the home on her husband's death, if they owned the home together as community property. If your mother had given the home to her children outright, then her basis would be your basis, and there would be a lot of capital gains tax due.
Because your mother reserved a life estate for herself, the entire property was subject to federal estate tax on your mother's death. This results in the property getting a "step-up" in cost basis. The basis is now the value of the home on your mother's date-of-death, plus the cost of improvements and minus any depreciation taken since then.
The tax that you and your siblings must pay will be calculated using this new basis. What you should do is to hire a certified appraiser to determine the value of your mother's home on her date-of-death, so you or your tax professional can properly report the tax due as a result of your sale of the home. Don't worry about property tax, however. Your mother's home wasn't reassessed upon her death because of the parent-to-child transfer exemption, and appraising the home for capital gains tax purposes will not trigger a reassessment.
As an aside, life estate deeds were used for many years as a means of protecting the family home from Medi-Cal estate recovery claims. New regulations the state is trying to get approved may change this. We will update you if and when this happens, so keep reading.
Len & Rosie
Dear Len & Rosie,
My mother and step-father purchased a home in 1976 for $60,000. He died in 1983 and left everything to mom. There was no probate. In 1993 mother created a revocable trust, and deeded the house into the Trust. After her death the trust first gives each of six grandchildren $2,000. The remainder of the trust (mostly her home) is to be split between my brother and myself.
My mother is very ill and near death but at 87 is still able to make decisions. Her house is currently worth $600,000. If we were to sell the house at the time of her death, will we owe taxes? Is there a better way to transfer property?
Stewart
Dear Stewart,
When your mother and her husband bought their home in 1976, the basis of the home was its purchase price of $60,000. When your step-father died in 1983, there was a step-up in cost basis. Today, the basis of the home is its value on your step-father's date of death.
If your mother were to sell the home today, then she would have to pay capital gains tax on the difference between the sale price and the home's 1983 value. Because she would be selling her home, she can deduct $250,000 in capital gains on her income tax return. But that might not be enough. If the home sells for more than $250,000 above its 1983 value, your mother will have to pay capital gains tax.
However, if your mother can continue to own her home until her death, then when she dies the property will get another step-up in basis, making the new basis the value of the home on her date-of death. Then, the successor trustee of her trust can sell the home and no capital gains tax will be due.
Right now, it appears that your mother has a proper estate plan. A revocable trust really is the best estate plan for her unless she is a Medi-Cal beneficiary and she needs to act to shelter her home from Medi-Cal estate claims. If your mother were to give her home away today, there would be step-up in basis on her death. This would cost you and your brother a lot of money in extra taxes that you should not have to pay. Your mother should keep her home within the trust.
Make sure that your mother's trust is properly funded with her home and her other assets. This way, there will not be a probate upon her death. After your mother dies you should hire an attorney to help you properly administer and distribute the trust.
Len & Rosie
Dear Len & Rosie,
My husband and I have no children or other relatives to whom we necessarily want to leave an inheritance. We were going to draw up a will, but I was told that unless we draw up a trust, if one of us passes away, we will be taxed heavily on the half we inherit from the other spouse. Would it be a great savings for us to get a trust for tax purposes as these, or is a will sufficient?
Cyndi
Dear Cyndi,
There will be no estate tax due when one of you dies if everything goes to the surviving spouse, no matter how rich you are because of the unlimited Federal Gift and Estate Tax marital deduction. There is never any estate or gift tax on property passing between spouses, regardless of whether there's a will, a trust, or no estate plan at all, unless the surviving spouse is not a United States citizen (and there are ways around that).
Your question is really about capital gains tax. When you die, everything that you own will get a step-up in cost basis. The basis of your home, other real property, and your stock and other business investments will be increased to the date-of-death value of each asset. Your heirs will be able to liquidate your assets and pay no capital gains tax on any of the growth in your assets during your lifetime.
You would think that when you or your husband dies, only the assets owned by the dead spouse will get a step-up in basis. But due to a quirk of the law, all of your community property, not just the dead spouse's half, will get a step-up in basis upon the first death. This will allow the surviving spouse to sell everything, if he or she wants to, and pay no capital gains tax. A trust is not necessary to accomplish this. You can title your assets as "community property with right of survivorship". You and your husband can also hold title as joint tenants, and have a written agreement saying that everything is community property.
Mind you, everything you and your husband acquires during your marriage as the result of your labor is by default community property. But the IRS doesn't always buy that argument in an audit, so it's best to play it safe and explicitly declare your assets to be community property.
The benefit of creating a trust would be to avoid probate upon the surviving spouse's death. But if you are not leaving your assets to anyone close, the need to avoid probate isn't so apparent. You may want to consider saving a few bucks now and creating wills instead of a trust.
Len & Rosie
Dear Len & Rosie,
My parents plan on giving my sister and me cash gifts of $50,000 each from the sale of a house. What is the best way for them to give it to us? I'm married with kids. My sister is divorced with kids.
Raylene
Dear Raylene,
Your parents can each give $12,000 to you, and to your sister, and to anyone else they want, each and every year because of the annual federal gift tax exclusion. If they give you less than $12,000 this year, they will not have to report the gift to the IRS, and you do not have to pay income tax on this gift either. Your parents could therefore each give you $12,000 this year, for a total gift of $24,000 with no tax effect.
If your parents give you the $50,000 all at once then they will have each given you $13,000 in excess of the annual gift tax exclusion. This means they would have to report these gifts to the IRS with a gift tax return (IRS Form 709) filed with next year's taxes. The gift tax owed on the excessive gifting will be paid by your parents' federal gift and estate tax unified credit. They will not actually have to pay gift tax to the IRS.
The tax effect of excessive gifting is that your parents' unified credit is reduced and the chance that federal estate tax will be due upon their deaths is increased. The bottom line is that it comes down to how rich your parents are. If they are not very wealthy, then they won't have enough assets to have to pay estate tax when they die anyway, so giving you the money all at once will have no effect.
On the other hand, if your parents are rich, wealthier than the $2,000,000 that can pass free of estate tax today, then they should limit the amount of money they give you each year to $12,000 or less. If they want, they can include your husband and children, and your sister's children in their generosity. Just keep in mind that if your parents make a gift solely to you, it's your separate property. If they give money to your husband, it's his separate property, so you may not want to ask your parents to give money to him.
One more thing. Many people do not understand that gift and estate tax law, and Medi-Cal planning, have nothing to do with one another. If your parents give way $100,000, there will be a substantial penalty if either of them should need Medi-Cal benefits. Gifting in amounts under the annual gift tax exclusion does not give them a free pass under Medi-Cal's eligibility rules.
Len & Rosie
Dear Len & Rosie,
My mother has a living trust. She's leaving her house to my son. Am I correct that the house will be reassessed for property tax and will also be subject to GST? Can you explain GST? What's the alternative? Leave the house to me? I already own a home.
Ellen
Dear Ellen,
It's a good thing that you are thinking about these issues. By doing so you may save your son thousands of dollars in property tax each year. You are correct in that your mother's home will be reassessed under Proposition 13 if she give it directly to your son. While there is a property tax reassessment exclusion for transfers between grandparents and grandchildren, this tax break would apply in your case only if you die before your mother and your son's father is also dead or he's married to another woman upon your mother's death.
The solution to avoiding a property tax reassessment would be for your mother to leave her home to you, as this is a transfer that qualifies for the Proposition 58 parent-to-child transfer exclusion. After you inherit the home you may give it to your son or leave it to him in your estate plan.
The only downside to doing this is that you have a one million dollar lifetime gift tax exemption. If you make a gift of this home to your son, you will have to file a gift tax return with the IRS and the amount of your own assets that will pass free of estate tax upon your death will be less. You and your mother should decide if the property tax savings for your son is worth the potential estate tax you may have to pay if you make this gift.
GST is the abbreviation for Generation Skipping Transfer Tax. This tax exists because the federal government wants to take an estate tax bite out of each generation. If your mother gives property to your son instead of you so that you wouldn't have to pay estate tax on it when you die, the government will collect less estate tax upon your death. So, they take a second bite out of your mother's estate in the form of GST. But you probably do not have to worry about this, because the GST exclusion is the same as the amount of your mother's assets that will avoid estate tax upon her death, which is $2,000,000 for 2006 through 2008. Unless the property passing to you son is worth more than that, there will be no GST payable to the IRS.
Len & Rosie
Dear Len & Rosie,
My sister recently divorced and she was able to keep the house, but she had to pay off her ex-husband $200,000 for his half. Our mother, who is 82 and is worth over $2,000,000, gave him the money to get him off the title to my sister's home.
What are the tax implications of this? My mother says she can take the money from my sister's inheritance. Everyone thinks this is a good idea. How do we do it? Should my mother be on title to the home with my sister? Should my sister give our mother a promissory note even though she wouldn't be able to make payments on it?
Wilson
Dear Wilson,
When a parent gives money to a child, it is presumed to be a gift and not an advancement against the child's inheritance. The best way of dealing with this, assuming your mother doesn't want or need the money back during her lifetime, is for your mother to amend her estate plan to take this gift into account. She can leave each of her other children $200,000 off of the top to make up for this gift, and then leave everything else equally among the children, assuming that this is what your mother wants to do.
There are not going to be any adverse tax consequences to this gift. Your mother will have to file a gift tax return, IRS Form 709, with her income taxes next year, but she will not have to pay any gift tax, because it will be paid by her federal gift and estate tax unified credit. The $200,000 gift will reduce the amount of your mother's assets that will pass free of estate tax by $188,000, which is $200,000 less the $12,000 annual gift tax exclusion, but this will not result in any more estate tax being due upon your mother's death. Your sister will not have to pay income tax on the gift.
Doing it this way is easier than your mother being on title to property with your sister, and it's probably more fair. It is also better than having a promissory note your sister won't be making payments on, because the tax authorities may assume the interest your sister doesn't pay as having been gifted back to her. Your mother could even be made to pay income tax on interest payments she never receives. Do not open this can of worms.
If your mother has a trust (which she ought to have, given that a $2,000,000 estate earns a lawyer $33,000 in probate fees), she can amend the trust to include a schedule of advancements against inheritance instead of just including the $200,000 gift to your sister. This way, she can record future gifts made to her children and avoid having to go back to her attorney every time one of her children needs more money.
Len & Rosie
Len Tillem and Rosie McNichol are elder law attorneys. Contact them at 846 Broadway, Sonoma, CA 95476, by phone at (707) 996-4505, or on the Internet at www.lentillem.com. Len also answers legal questions each weekday, Noon-12:45 PM, and Sundays, 4-7 PM, on KGO Radio 810 AM.
