For Many with Money, the Temporary Repeal of the Estate Tax Will Increase their Death Taxes

Beware of TV Commentators. A TV financial commentator made the morbid comment this weekend that 2010 is the year to die because there is no federal estate tax in 2010. What he ignored is that the arcane tax law provides that for many with money in 2010, they will actually pay more taxes with the repeal of the estate tax if they die in 2010. So, if you are single or in a second marriage, have between $1.3 and $3.5 million, don’t use dying in 2010 as a tax planning strategy.

Temporary Repeal. Under current law, effective January 1, 2010, the federal estate tax is repealed until January 1, 2011, when the federal estate tax returns with a vengeance with a tax on everything above $1,000,000 and up to a 55% rate. There is legislation pending which would bring back the estate tax in 2010 with an exclusion of $3.5 million for 2010 and the next several years. Congress will probably try to reinstate the estate tax retroactively to January 1, 2010, making the pull the plug strategy for 2010 even a worse idea. More on that in a future blog. The federal estate tax is a tax on the estate of everything above the exclusion amount, except that bequests to your spouse and to qualified charities are federal estate tax free. Also, many states still have an estate tax and some have an inheritance tax.

Step Up in Basis Is a Big Deal. Before 2010, if someone died, their heirs received their property at the market value of the property as of the date of death of the decedent, or an alternate date. In tax talk, this means their “basis” in the property increased and was “stepped up” to current market value.

Dr. Sam Dies in 2009: No Death Taxes. Dr. Sam (a widower) bought a house in the suburbs for $100,000 which is now worth $900,000. The basis of Dr. Sam in his house is $100,000 (what he paid of it in 1981), plus another $100,000 in improvements, for a total basis of $200,000. If Dr. Sam sold his house for $900,000 and assuming it is eligible for the $250,000 homeowner exemption from capital gain taxes, his taxable gain is $900,000 less his basis of $200,000 less homeowner exemption of $250,000 or $450,000 in total ($900,000-$200,000-$250,000 =$450,000). Dr. Sam’s capital gain tax is a combined federal and state rate of about twenty percent (20%) times $450,000 or $90,000. If Dr. Sam had died in 2009, his daughter and sole heir Sally Sue would have received an increase in Sally Sue’s basis to $900,000, the market value of the house as appraised in the estate of Dr. Sam. Therefore, Sally Sue sells the house for $900,000 after expenses and because her basis was “stepped up” to the value in Dr. Sam’s estate, Sally Sue pays no capital gains because Sally’s stepped up basis is the same as what she sold it for. If Dr. Sam’s estate was less than $3.5 million, his estate pays no estate taxes.

Dr. Sam dies in 2010: $160,000 in Capital Gains Taxes. As a way of raising tax money to replace the revenue “lost” from the repeal of estate taxes, Congress also repealed step up in basis for property received from a decedent. So, if Dr. Sam died in 2010, when there is no step up in basis, Sally Sue receives the basis for Dr. Sam’s house of $100,000, assuming Sally Sue found proof of the $100,000. Sally Sue is very unlikely to find the receipts of Dr. Sam to prove that Dr. Sam made $100,000 of improvements. Sally Sue has not lived in the house and the five year period to qualify for the homeowner residence deduction of $250,000 has expired. Sally Sue’s capital gain in 2010 is $900,000 less $100,000 which is $800,000 ($900,000-$100,000=$800,000). With an estimated 20% combined federal and state rate, Sally Sue pays $160,000 in taxes on the sale of Dr. Sam’s house in 2010 if the house is not covered by the $1.3 million exemption. Sally Sue may experience a $160,000 tax increase due to the one year repeal of the estate tax.

Paper Chase Harassment. Sally Sue has the paper chase harassment of trying to find proof of what Dr. Sam paid for his house in 1981, what he paid for his Microsoft stock in 1982 and what grandmother paid for the family cabin in 1932 before she gave it to Dr. Sam. Finding proof of the basis in assets of a decedent will be very difficult. Sally Sue will have to document her claims of her basis to the IRS. The title companies, the stock brokerage companies, and most of the public will go crazy trying to figure out what parents, aunts, and uncles paid for things during their lifetime. But the anal record keeper gets to finally say with glee: “See, I told you never to throw out those papers from the thirties”.

Exceptions & Exemptions. Of course, it would not be the American tax law unless there were exemptions and exclusions. There is a $1.3 million allowance for a step up in basis and an additional $3,000,000 spousal exemption. For people who are not US citizens or US residents with investments in the US, the exclusion is only $60,000. The net effect of this is that if you are single or married with an estate plan that does not capture the spousal exemption, you still have a death tax in the form of future capital gains for your heirs and your exemption is no longer $3.5 million as it was in 2009, but only $1.3 million plus proof of your basis in assets not covered by the $1.3 million. Since many people are widowed when older and most don’t have estates greater than $3.5 million, 2010 is the year when the taxes to be paid by their heirs on their inheritance increased up to $440,000.

Update your Plan. Will your estate plan survive 2010? In the estate plans we have been doing in the last several years, the 2010 temporary repeal is covered. But, many other plans do not cover this. There are new planning opportunities to take advantage of this one year repeal of the estate tax. Call us to go over whether your plan is up to date, uses all of the new exemptions and how you can take advantage of current rules.

Best Last Minute Tax Deduction at the End of the Year: Charitable Remainder Trust

Have Taxable Income or Gain. If you had substantial income or have a large taxable gain in 2009 or will in future years, the best end of year tax savings technique is often the Charitable Remainder Trust (CRT). This is because with a CRT, you can obtain a large tax deduction even if you wait until the end of the year. Many of the other techniques that taxpayers used in the past for end of year tax deductions have been severely limited. With the CRT, you retain some control over the asset, receive income from it, get an immediate tax deduction and postpone or avoid capital gains on the sale of the asset.

What is a CRT? A CRT is a trust which you create and to which you contribute assets such as stocks or free and clear real estate. The CRT then sells the asset and because the CRT is similar to a charity which pays no income taxes for charitable activities, the CRT does not pay any capital gains at the time of the sale of the property. Depending on how you set up the CRT, you may never pay any capital gain taxes on the sale of the asset.

Major features of the CRT:

*Planning A Must. The first step is to plan the CRT, which involves integrating your CRT into your financial, business and estate plan:
*Not Too Big and Not Too Small Deduction. You generally want to maximize the deductions you will receive in the year of the gift. The deduction is calculated based upon IRS tables which predict how much the charity will receive. If you contribute $100,000 in 2009 to the CRT and the IRS tables say the charity is predicted to receive $30,000, you receive a $30,000 deduction from your taxes in 2009. If you exceed the maximum deductable level for charitable deductions in year 2009, you can carry forward the deduction to use in future years, with certain limitations. You do not want to give too much or too little.
*Charity Minimum Ten Percent. The charity has to receive at least 10% of the total gift. If you are below 50 years of age, you may not be able to use your lifetime as the time for the payments back to you from the CRT and may have to use a maximum of 20 years before the assets go to the charity. As part of the planning, we run computer calculations of the results of different options.
*Payout Rate. You have to decide the annual rate at which the CRT will pay you. It has to be at least 5% and not more than 50% and it can be fixed or dependent upon earnings or the value of the property. The pay out rate is the rate at which you will receive income for your life or the set period of the CRT.
*Distributions Taxed. You pay taxes on the distributions if they are ordinary income or capital gains, but not return of principal or tax exempt income.
*Postpone Income Taxes. If you will have high income for the next several years, high taxes and do not want to receive any payments which would be subject to taxes, you can set the CRT up so that the CRT does not make payments to you during the high income years through the use of financial instruments such as an annuity or family limited partnerships. You can turn the cash flow spigot on or off depending upon your future cash needs. The IRS is watching for abuses.
*Appraisals. If you contribute to the CRT real estate or a hard to value asset such as an interest in a closely held business, you must have an independent appraisal and a special independent trustee involved in the process.
*You are the Trustee. You can be the trustee of the trust, but there are self dealing limitations.
*Option to Change Charity Designated. You initially name the charity, but you can retain the right to change the charity. Properly planned, your family foundation may become a beneficiary.
*Exempt from Estate Taxes. The assets in the CRT will not be part of your taxable estate and you do not use up any of your exemptions from estate taxes by use of the CRT.
*Replace the Inheritance. Since the assets go to the charity upon your passing and not to your heirs, you can decide to replace those assets with life insurance. If is possible to so design a CRT in many cases where the net tax and other financial advantages provide enough additional cash to pay for the insurance.
*Money is in the CRT. Once established, you can not change the rules of the CRT and take back the asset. You have to be able financially to not have this as an asset that you must liquidate to pay bills. However, with the deferred income CRT, you can sell assets in the CRT when you need money so that you receive all of the distributions you did not receive over the prior years.

Your Team of Advisors. There are exceptions and many details to this planning not discussed above which you do not need to know in order to accomplish your goals. The key point is that there is a way to obtain large last minute tax deductions at the end of the year. The CRT will be used more in the future as capital gains rates, income tax rates and estate tax rates increase in the coming years. If you want to plan for the coming higher taxes, we will assemble your team of advisors to use the tools permitted under the law to lessen the blow of these higher taxes on you.

How to Protect Yourself: US Goes Bankrupt: Taxes Going Up, Services Going Down; President Obama Tells the Truth

You Can’t Handle the Truth: When I was in politics for ten years as a member of the Virginia legislature, most politicians believed that the “people” couldn’t handle the truth. My experience was that people didn’t like to hear about the harsh realities that government often faces.

Obama Tells the Truth. President Obama did a public service for the country when he said the US is going bankrupt unless we raise taxes and cut spending. Now, the President didn’t say it exactly that way, but the pending health plan in the Senate recommended by the President relies upon decreasing expenditures for Medicare and Medicaid and raising taxes. New Hampshire Republican Senator Gregg claims current and proposed spending will lead to bankruptcy for the United States.

Unsustainable Budget. In our private client letter mailed in December 2008, I quoted: “Under any plausible scenario, the federal budget is on an unsustainable path”-Peter Orszag, Director, Congressional Budget Office, December, 2007. This was before the historic spending of 2009. In our Prepare for the Return of the Estate Tax, we provided the numbers which show how the government is going broke. The Obama Administration is projecting a $9 Trillion deficit in the next ten years. This is more debt than America accumulated from 1789 to 2008 combined. The Heritage Foundation says the correct number is $13 Trillion over ten years with the national debt being equal to the entire production of the country (GDP) by 2019. At some point, the federal government will no longer be able to borrow money at acceptable rates to finance spending. The projected rates of spending will force punishingly high taxes on individuals, businesses and the economy. So, what do you do if the US government goes bankrupt?

Capital Gains. The 15% federal capital gain rate expires by law at the end of 2010. Rates will go higher. Strategies include selling of stock now with capital losses to store up loses against future taxes, use of charitable trusts to postpone or avoid gains and use of tax deferred exchanges for real estate.

Income Taxes. The maximum 35% personal rate expires at the end of 2010. Rates will probably go to $39.5%. With increases in state taxes, phase out of deductions and the raising of the ceiling on withholding taxes, the effective rate could be near 60%. Business owners will increase corporate perks and take another look at deferred compensation planning. Tax payers will seek charitable planning, annuities, life insurance and tax shelters.

Estate Taxes. We predicted the $1,000,000 exemption and 55% tax rate is coming back in Prepare for the Return of the Estate Tax. There are time tested techniques to legally reduce your estate taxes to zero even if you have a large estate.

Decline of the Dollar. If the US government goes bankrupt, the value of the dollar will decline greatly and the prices you pay will increase greatly. If all of your assets are in dollars denominations, you will have to work to able to pay your bills, if you can find a job that pays enough to live on. Talk with your financial advisor about whether you should diversify a substantial amount of your portfolio into assets in currencies other than dollars, assets that will retain their buying power or other defensive moves. There is a historically wide variation of opinion among economists as to whether we will have inflation or deflation.

Health Care. It is well known and documented that the path to saving on personal health care expenses is to control your weight, exercise, get a good nights sleep, avoid fast foods, eat a Mediterranean diet, avoid harmful medicines, have a warm and loving family, avoid narcotics and excess alcohol consumption, reduce stress and feel you are making a worthwhile contribution to your community. Sounds simple enough-for the perfect person. A large number of people I know think that their health care is in their hands and that they will not be able to depend upon a government provided health care system. My personal recommendation is for you to read a book such as “Ultraprevention: The 6-week Plan that Will Make you Health for Life” by the two medical doctors who run the Canyon Ranch health spas. We will give away copies of this book to the first ten people who call Silvio at 571-633-0330 and to anyone who comes in for an appointment to plan their taxes, estate or business.

Be Ready. Call us to have a balanced plan for the coming years of more financial turmoil.

Is the Tiger Woods’ Pre Nuptial Agreement Protected Against Multiple Mistresses?

Tiger Woods. We are reading press reports that Tiger Woods may pay an additional $5 million and up to $80 million to his wife, Elin Nordegren, the mother of their two children, to stay with him after revelations of multiple mistresses. Under the reported original pre nuptial agreement, Tiger Woods agreed to pay Elin $20 million if she agreed to stay with him for ten years. The additional sums are payments to her to be the dutiful wife even though he has reportedly had multiple affairs.

A PreNup. A pre nuptial agreement is a legal agreement entered into prior to marriage waiving the normal legal rights of a spouse. In general, in the event of a divorce, each spouse often receives one half of all of the property acquired during the marriage. This could include any increase in the value of a business owned by a spouse, or real estate or a stock portfolio even though the business, real estate and stock portfolio was owned by the spouse prior to the marriage. If the wife is a stay at home mom, she may receive part of the pension fund of her husband, child support and alimony for a time period until she is able to re enter the work force.

Celebrities. You often hear about celebrities such as Tiger Woods, Paul McCartney, or Michael Jackson entering into pre nuptial agreements to protect against losing half of their multi millions in the event of a later divorce.

Business Owners Too. We have done pre nuptial agreements for stock brokers, owners of contracting companies, professionals and real estate developers who have wealth to protect, but are not celebrities. Usually, the man requests the pre nuptial agreement because he believes he “was taken to the cleaners”-i.e. lost half of his wealth in his last divorce. Sometimes the successful business woman or heiress of a substantial estate also is motivated to obtain a prenuptial agreement. We have represented the less wealthy spouse as well in many cases.

What it Says. Usually, both sides agree to give up their rights to take half of the property bought into the marriage and any growth in value of that property. They also agree not to make any claims against the retirement funds or separate investments of the other spouse made during the marriage. They waive any rights to alimony or to receive an inheritance from the spouse. For the spouse who is not as well off, often there is a promise of a minimum income or a life insurance policy in the event of the death of the wealthier spouse during the marriage. A pre nuptial agreement can be combined with an estate plan so that if there is divorce during the marriage, there is no inheritance, but if the wealthier spouse dies during the marriage, the surviving spouse will have enough funds to continue their life style and raise their children.

What it Should Say: To be enforceable, the pre nuptial should have the following:
*Full disclosure of all of the assets and income of each person.
*Separate legal representation by both spouse.
*Full understanding of what each spouse is giving up.
*How the ownership of the residence will be handled.
*Equal division of marital property upon divorce.
*Financial support for the stay at home mom who removes herself from the workforce and the ability save for retirement while taking care of the children.

What Not to Do: Preparing for a marriage and a prenup causes enormous stress, but in the long run the marriage will be stronger if you are fair and sensitive to the other person:
*Do not hide any assets from the other spouse. This will be strong grounds to set aside the agreement.
*Do not have one attorney draw up the agreement with no review by an independent attorney representing the less wealthy spouse.
*Failure to determine how money will be handled in the marriage.
*Failure to understand that the less wealthy spouse will feel that she is not being trusted by her new husband; she has to understand it is not about her, but about the emotional scars of her husband.
*Finalizing the prenup two days before the wedding after the family is in town and no one knows whether the wedding will take place. I have seen this happen a couple times and when I am one of the lawyers, it reminds me why I am not a divorce lawyer.
*Failure to integrate the prenup into the financial and business plans of the new family.

After the marriage. If you don’t follow your marriage vows, don’t expect the prenup to have much meaning or legal effectiveness. The courts often do not favor prenuptial agreements and will look for loopholes not to enforce them. But, a faithful spouse with an effective pre nuptial agreement will be protected in the event his spouse runs off with the pool boy or an errant husband with a cocktail waitress.

Get Five Times the FDIC Insurance Against Bank Collapse by Use of Your Living Trust

Bank Failures. There have been over 100 bank failures this year and many more are expected next year. If you have deposits in a bank, what happens to your money when the bank fails? [click here for a list of bank failures throughout United States] Because of the run on banks in the Great Depression of the 1930s, the Congress established the Federal Deposit Insurance Corporation (FDIC) to provide insurance when a bank fails. If another bank does not take over the failing bank and guarantee all of the deposits of the failed bank, then the FDIC steps in and pays the consumers who had deposits in the failed bank up to the maximum insurance limit then in effect. Until January 1, 2014, when the maximum insurance reverts to $100,000, the present maximum insurance is $250,000 per person.

Auntie Mae. Auntie Mae is worried that she may live longer than her money. She keeps nearly everything in cash and money market accounts. Her life savings, everything she inherited from her sisters and deceased husband totals about $800,000 which she has in her checking, savings, money market and other accounts. She put $100,000 in eight separate branch offices of a local bank, thinking that would protect her. She didn’t want to have to deal with several banks which she did not know and trust. She was afraid to put her daughter’s name on the accounts because her daughter is a pediatrician and although her doctor daughter has not been sued, pediatricians are often targets of lawsuits. When her bank failed and closed its doors, the FDIC paid her $250,000, the maximum insurance under this federal guarantee system, and she lost $550,000, most of her life savings. Auntie Mae will have to get a job at Wal Mart because she does not now have enough money to live on.

The Living Trust Solution. For years, there was confusion and uncertainty as to how FDIC insurance worked for accounts held in living trusts. This was clarified last year by the FDIC and there is now a “five-times” rule. Under the five times rule, if you have five or more beneficiaries of your estate in your trust, then you receive at a minimum five times the current maximum level of insurance on all of your accounts at the bank. With the five times rule, you will have a minimum of $1,250,000 of FDIC insurance for accounts held in your living trust at a single bank. You can have more than $1,250,000 in FDIC insurance with a living trust, but if there are over five beneficiaries, the FDIC will look at the actual amounts left to all of the beneficiaries and limit the amount by the lesser of $250,000 per beneficiary or the actual amount given. There is no extra charge to you for this additional FDIC insurance. The $1,250,000 of insurance will take care of most accounts. After 2013, this is scheduled to reduce to $500,000.

How it works. Auntie Mae puts all of her checking, savings and bank money market accounts into the name of her living trust. She does this by going to her bank and having the ownership of the account changed to the name of her living trust. Auntie Mae has left 50% of her estate to her daughter Ellen, 20% to her nephew, $10,000 to the aide who helps her each week, $10,000 to the Salvation Army and $10,000 to a friend. This means she has five beneficiaries; the old requirement of family members as the only qualifying beneficiaries is gone. As a result, the bank and FDIC now provide her accounts up to $1,250,000 in FDIC insurance even though all of her accounts are in one bank. She does not have to spread her money into different accounts at different banks, which could lead to great confusion and complexity. If her bank went under, all of her $800,000 will be protected by FDIC insurance.

Transfer Your Bank Accounts to Your Trust Now. Many people put off putting their personal savings and checking accounts into the name of their living trust. Now, you have a very strong reason for doing this-getting five times the FDIC insurance.

Dad Died and the Bank Took Everything

Successful Contracting Company. Jimmy Jones had a successful contracting company which was worth several million dollars. Over his lifetime, he had seen the business go up and down with the economy. To put away some funds for the future, he bought an apartment building and a small shopping center. Jimmy worked until his seventies and never found the right person to take over his company. His daughter Jane is a successful CPA with her own practice but his son Jimmy Jr. drifts from job to job. Jimmy gave his children everything when they were growing up because he didn’t want his children to remember being poor as a child.

Great Banking Relationship. Jimmy has had a great relationship with his local community bank where he had his business accounts over the years. He had a line of credit and commercial loans on his apartment building and shopping center all with the same bank. He thought he saved on legal fees when he obtained or renewed his loans by not having a lawyer review the documents.

MegaBank Takes Over. On Friday the 13th of November, Jimmy had a heart attack and died. All of the loan documents for his business and his real estate have a clause in the loan documents which say that if Jimmy died, the bank could demand full payment immediately on all of his loans. Recently, his local community bank had been acquired by MegaBank which now has all of Jimmy’s loans. MegaBank has been kept out of bankruptcy by billions of dollars from the federal government. The federal regulators want MegaBank to have higher cash reserves in case of loan defaults and to get rid of all risky loans, which the regulators classify as including all commercial loans on local real estate to individual owners. Jimmy had always paid all of his loans on time and the business and real estate generated enough cash flow most months to pay all of the loans; Jimmy was an excellent credit risk. Now, because Jimmy has no successor in place to take over his construction business and manage his real estate, MegaBank feels itself insecure, is being pressured by the regulators and therefore declares due and immediately payable all of the loans that Jimmy had with the bank based upon the clause in the loan documents that the bank can demand immediate full payment if the borrower dies.

MegaBank Wins in Court. Jimmy’s daughter Jane hires an attorney to try to stop the foreclosures on the business and the real estate. Jane loses in court because the loan documents clearly allowed MegaBank to foreclose if Jimmy died. Jane pays $120,000 in legal fees out of her savings and MegaBank adds its legal fees of $150,000 to the balance due on the loans owed by Jimmy’s estate. Due to the depressed construction industry during the recession and the decrease in values for the real estate and the shortage of loan money, Jane can not get loans to stop the foreclosures. After MegaBank foreclosed, Jimmy’s construction company closed its doors and 32 people lost their jobs. The real estate was sold at fire sale prices for less than the balances on the loans. MegaBank came after Jimmy’s savings and wiped out any other money he had that did not go by right of survivorship to Gerry, Jimmy’s widow. Jimmy’s widow sells her house to have money to live on and moves in with her sister and her sister’s crude and rude husband. Jimmy’s children, who could have each inherited millions, will get no significant inheritance from their parents.

Prevention. This could have all been prevented. “Death is a default” is a standard term in commercial loan documents that can be removed through negotiations. If Jimmy had hired our firm to represent him with his commercial loans, we would have insisted that the loan commitment letter state that the loan could not be called by the bank if Jimmy died. We would have worked with Jimmy to have a business succession plan in place that we would show to the bank to convince them that they would still be paid if Jimmy died. We have always been able to obtain bank agreement that the loan could not be called in the event of the death of the principal borrower. MegaBank would not have had the right to foreclose and the Jimmy Jones family assets would have been saved and Gerry would not have had to move in with her sister and her rude husband. Many entrepreneurs do not use competent legal counsel to review the commercial loan commitment letter before their sign it. This story shows what can happen to a lifetime of work and a family if you do not obtain the proper loan terms.

Don't Put Children on Title to Your House

Add Ellen to the Deed. When I did a weekly talk radio show for WRC in Washington in the 90s on real estate, every week a little old lady would call me about putting her daughter (Ellen) on the title to her home. The mother wanted to do this as a cheap and easy way to plan her estate. If she died with the house in the joint name of her and her daughter with right of survivorship, the house would automatically go to the daughter. No probate, no will and no need for a living trust or to talk to a lawyer. I always spoke against this idea.

Joint Liability. When the mother puts her daughter Ellen on title, the daughter becomes a joint owner. As a joint tenant, most states treat this as tenants in common for the purposes of liability. Ellen has a car accident and a judgment for $2,000,000 is entered against her. Ellen’s insurance limit is $500,000. The trial lawyer who got the judgment comes after all of Ellen’s property. Now that Ellen is a co owner of the home, the trial lawyer can get a court order requiring the sale of Ellen’s interest in mom’s home and mom gets evicted from her home, or has to buy off the trial lawyer. If Ellen gets divorced, a half of mom’s house may be part of the divorce property settlement with the ex son in law.

Medicaid Denial. Under current Medicaid rules, a transfer to a child would be a gift and would disqualify the mother from Medicaid for up to five years, depending upon the appraised value of the house at the time of the gift and other factors.

Can’t Sell. Mom can’t sell the property to a legitimate buyer without Ellen’s signature. When the house is sold, Ellen is under no legal obligation to give any of the house proceeds to mom. What happens if mom needs the money for a nursing home and Ellen needs the money for a life threatening illness of one of her children? If mom has Alzheimer’s, has a stroke or becomes incompetent, no one can sell the house until Ellen engages in an expensive and time consuming guardianship court procedure. When parents put children on title to their homes and later take them off to get a loan or sell the property, we have often found that there are title problems that prevent a later sale.

Vulture Takes Mom’s Home. A vulture investor may be willing to buy out Ellen at bargain prices for a payment of quick cash to Ellen. Mom can’t legally stop the vulture investor from then obtaining a court order for the sale of mom’s home.

Gift Tax. Mom has made a gift to Ellen which will probably be subject to a gift tax. If mom’s house is worth $500,000 and she owns it without debt, the gift to the daughter is $250,000, $237,000 more than the annual exemption of $13,000 from gift taxes in 2009. Should mom file a gift tax return? If mom intended a gift, then she is required by the tax law to file a gift tax return and use $237,000 of her $1,000,000 exemption from gift taxes. If mom sells the house and Ellen agrees that all of her share, worth $250,000, should go to mom, then Ellen has given $237,000 to mom and should file a gift tax return.

Pay Capital Gains Tax Unnecessarily. If mom filed a gift tax return or if Ellen can’t prove to the IRS that mom didn’t really give her anything in the house, then Ellen received one half of mom’s house based upon her mother’s basis in the property. Mom and dad (now dead) had paid $50,000 for the house and Ellen can’t find the receipts for improvements made during the lifetime of her parents. Therefore, mom’s basis in the property is $50,000. Ellen receives a basis of $25,000 in Ellen’s one half interest in mom’s house; one half of the mother’s basis of $50,000 is $25,000. When Ellen sells the house for a net of $600,000 after mom dies, Ellen unnecessarily pays a capital gain tax on one half of the house of about $55,000 at current rates and more with higher rates in the future.

Loans. How it happens, I don’t know. But, there are cases where a child goes out and gets a loan on the house without telling mom, the child pockets the money and later is unable to pay the loan. Mom loses her house in her old age to foreclosure. Or, mom wants to get a reverse mortgage and can not because the daughter is on title to the house.

Family Destruction. Mom had two daughters and son and mom’s will says everything goes in an equal split one third to each child. But, mom’s house passes outside mom’s will so her daughter Ellen receives not one third of the house, but 100% of the house. The will usually does not equal this out. Ellen must now decide whether to take money from Ellen’s family and give two thirds to her siblings and use up part of Ellen’s gift and estate tax exemptions for her gift to her siblings. If Ellen doesn’t do that, her sibling will believe that Ellen plotted this from the beginning so that Ellen could steal mom’s house from her brother and sister.

Living Trust. If mom had instead set up a living trust and named herself and Ellen as the trustees of the trust, she could have avoided all of these problems. We will cover the issues later that arise from putting a home in a living trust. After mom got off the radio talking to me, did she follow my advice? Probably not.