Can I Bequeath My Home to My Children without Taxes?

As part of your estate planning, you can pass your house tax-free to an heir. savingadvice.com’s recent article entitled “Use These Tips to Pass Your House to Your Heirs Tax-Free” reminds us that the most important thing is to look at the total value of your entire estate (not just your home). If the value is more than $11.58 million (the unified federal estate gift and estate tax exemption amount for 2020), then your estate will be subject to estate taxes. If it’s under that amount, there’s no worries, and you can pass a house tax-free through a will. However, you may also have state estate taxes on the inheritance.

Ask an experienced estate planning attorney about the potential capital gains taxes your heirs may have to pay, when they sell the property. If you owe any money to Medicaid upon your death, the state can place a lien on your property, which can affect your heirs. Let’s look at some options to discuss with your estate planning attorney:

Irrevocable Trust. If you have an estate that’s more than the $11.58 million amount, you might want to look at putting the house into an irrevocable trust, instead of just including it in your will. Ask your attorney about a qualified personal residence trust. When you die, the house will go to the heir(s) that you’ve designated with the trust. However, if you sell the house, the money goes into the trust and can’t be cashed out if the situation changes. It’s something to consider, if you have a high-value estate and want to pass a house tax-free to your children or other loved ones.

As a Gift. You can gift a house to your children, and there will be no taxes on that, if the value of your home is less than the $11.58 million. However, you must file a gift tax form when you do your annual taxes. As long as the value is below that amount, it should just be a matter of filing the form and not paying any fees.

Look at total value of your estate and your home. File a gift tax form with the IRS in the year that you gift the home and offset the total amount of the gift by first using your annual gift-tax exclusion of $15,000. This is per donee and per donor, so if you and your spouse jointly own the property and you gift it to multiple children, you can up the exclusion amount.

You shouldn’t apply for Medicaid within five years of gifting your home to your child, because there may be a transfer penalty if you gift assets just before applying for Medicaid benefits.

Can You Sell the House and Gift the Money? You can sell the home at current market value, then gift that money to your child. You can do this in a will or trust or give it to them directly. You could also sell the home to your child at a very low price. They’d get the house and can sell it themselves at a higher value when the time is right for them to do so. However, they may have to pay higher taxes when they do.

Selling your Home to Your Child for $1? OK, you’re technically selling the house, so it’s not a gift. However, the remainder of the value of the house is considered a gift, so the gift tax rules still apply. If your child sells the house, they must report the entire difference as a gain, which means capital gains taxes.

If you want to sell your house to your child, you should consider selling it to them with a small down payment as a seller-financed sale. You’ll carry the note for the balance, and your adult child will make affordable payments. You can even offset what they pay you, by gifting them up to $15,000 per year (which is low enough not to trigger the gift tax). Since you’ve sold the home, it’s no longer a part of your estate, so you don’t have to worry about taxes on your end.

Reference: savingadvice.com (July 29, 2020) “Use These Tips to Pass Your House to Your Heirs Tax-Free”

State Laws Have an Impact on Your Estate

Nj.com’s recent article entitled “Will N.J. or Florida’s tax laws affect this inheritance?” notes that first, the fact that the individual from Florida isn’t legally married is important.

However, if she’s a Florida resident, Florida rules will matter in this scenario about the vacation condo.

Florida doesn’t have an inheritance tax, and it doesn’t matter where the beneficiary lives. For example, the state of New Jersey won’t tax a Florida inheritance.

Although New Jersey does have an inheritance tax, the state can’t tax inheritances for New Jersey residents, if the assets come from an out-of-state estate.

If she did live in New Jersey, there is no inheritance tax on “Class A” beneficiaries, which include spouses, children, grandchildren and stepchildren.

However, the issue in this case is the fact that her “daughter” isn’t legally her daughter. Her friend’s daughter would be treated by the tax rules as a friend.

You can call it what you want. However, legally, if she’s not married to her friend, she doesn’t have a legal relationship with her daughter.

As a result, the courts and taxing authorities will treat both persons as non-family.

The smart thing to do with this type of issue is to talk with an experienced estate planning attorney who is well-versed in both states’ laws to determine whether there are any protections available.

Reference: nj.com (July 23, 2020) “Will N.J. or Florida’s tax laws affect this inheritance?”

Should I Give My Kid the House Now or Leave It to Him in My Will?

Transferring your house to your children while you’re alive may avoid probate, the court process that otherwise follows death. However, gifting a home also can result in a big, unnecessary tax burden and put your house at risk, if your children are sued or file for bankruptcy.

Further, you also could be making a big mistake, if you hope it will help keep the house from being used for your nursing home bills.

MarketWatch’s recent article entitled “Why you shouldn’t give your house to your adult children” advises that there are better ways to transfer a house to your children, as well as a little-known potential fix that may help even if the giver has since passed away.

If you bequeath a house to your children so that they get it after your death, they get a “step-up in tax basis.” All the appreciation that occurred while the parent owned the house is never taxed. However, when a parent gives an adult child a house, it can be a tax nightmare for the recipient. For example, if the mother paid $16,000 for her home in 1976, and the current market value is $200,000, none of that gain would be taxable, if the son inherited the house.

Families who see this mistake in time can undo the damage, by gifting the house back to the parent.

Sometimes people transfer a home to try to qualify for Medicaid, the government program that pays health care and nursing home bills for the poor. However, any gifts or transfers made within five years of applying for the program can result in a penalty period, when seniors are disqualified from receiving benefits.

In addition, giving your home to someone else also can expose you to their financial problems. Their creditors could file liens on your home and, depending on state law, get some or most of its value. In a divorce, the house could become an asset that must be sold and divided in a property settlement.

However, Tax Code says that if the parent retains a “life interest” or “life estate” in the property, which includes the right to continue living there, the home would remain in her estate rather than be considered a completed gift.

There are specific rules for what qualifies as a life interest, including the power to determine what happens to the property and liability for its bills. To make certain, a child, as executor of his mother’s estate, could file a gift tax return on her behalf to show that he was given a “remainder interest,” or the right to inherit when his mother’s life interest expired at her death.

There are smarter ways to transfer a house. There are other ways around probate. Many states and DC permit “transfer on death” deeds that let people leave their homes to beneficiaries without having to go through probate. Another option is a living trust.

Reference: MarketWatch (April 16, 2020) “Why you shouldn’t give your house to your adult children”

What Exactly Is the Estate Tax?

In the U.S., we treat the estate tax and gift tax as a single tax system with unified limits and tax rates—but it is not very well understood by many people. The Motley Fool’s recent article entitled “What Is the Estate Tax in the United States?” gives us an overview of the U.S. estate and gift tax, including what assets are included, tax rates and exemptions in 2020.

The U.S. estate tax only impacts the wealthiest households. Let’s look at why that’s the case. Americans can exempt a certain amount of assets from their taxable estate—the lifetime exemption. This amount is modified every year to keep pace with inflation and according to policy modifications. This year, the lifetime exemption is $11.58 million per person. Therefore, if you’re married, you and your spouse can collectively exclude twice this amount from taxation ($23.16 million). To say it another way, if you’re single and die in 2020 with assets worth a total of $13 million, just $1.42 million of your estate would be taxable.

However, most Americans don’t have more than $11.58 million worth of assets when they pass away. This is why the estate tax only impacts the wealthiest households in the country. It is estimated that less than 0.1% of all estates are taxable. Therefore, 99.9% of us don’t owe any federal estate taxes whatsoever at death. You should also be aware that the lifetime exemption includes taxable gifts as well. If you give $1 million to your children, for example, that counts toward your lifetime exemption. As a result, the amount of assets that could be excluded from estate taxes would be then decreased by this amount at your death.

You don’t have to pay any estate or gift tax until after your death, or until you’ve used up your entire lifetime exemption. However, if you give any major gifts throughout the year, you might have to file a gift tax return with the IRS to monitor your giving. There’s also an annual gift exclusion that lets you give up to $15,000 in gifts each year without touching your lifetime exemption. There are two key points to remember:

  • The exclusion amount is per recipient. Therefore, you can give $15,000 to as many people as you want every year, and they don’t even need to be a relative; and
  • The exclusion is per donor. This means that you and your spouse (if applicable) can give $15,000 apiece to as many people as you want. If you give $30,000 to your child to help her buy their first home and you’re married, you can consider half of the gift from each spouse.

The annual gift exclusion is an effective way for you to reduce or even eliminate estate tax liability. The estate tax rate is effectively 40% on all taxable estate assets.

Finally, the following kinds of assets aren’t considered part of your taxable estate:

  • Anything left to a surviving spouse, called “the unlimited marital deduction”;
  • Any amount of money or property you leave to a charity;
  • Gifts you’ve given that are less than the annual exclusion for the year in which they were given; and
  • Some types of trust assets.

Reference: The Motley Fool (Jan. 25, 2020) “What Is the Estate Tax in the United States?”

What Does Portability Mean, and How Do I Use It?

WMUR’s recent article, “Money Matters: Portability and estates,” explains that each taxpayer is typically permitted what is called an applicable exclusion amount. This is the amount of assets that, at your death, you can bequeath to others tax-free for estate tax purposes. Prior to the law change, spouses couldn’t share their exclusions. However, the Tax Cuts and Jobs Act increased this exclusion significantly. In 2019, the exclusion is $11.4 million per person.

The portion that’s not used by the deceased spouse can be transferred to the surviving spouse. The exclusion is indexed for inflation. However, this exemption level is only in effect until 2025. It will then again lower, probably to around half of its current level.

Before this tax law change, the most frequent way to maximize the exclusion was to set up a trust for each spouse—sometimes known an A/B trust. When the first spouse passes away, an amount equal to the exclusion would go to the B trust (also called a credit-shelter bypass trust).

The assets in this trust would be outside the surviving spouse’s estate and, because the exclusion was applied, were not subject to estate taxes. Anything remaining in the estate of the first to die, would be given to the survivor or could be placed in another trust. This trust is often called an A trust (or marital trust). Transfers to spouses aren’t usually subject to estate tax, so assets passing to the A marital trust would have no estate tax liability. At the surviving spouse’s death, his exclusion would be applied to the assets in the A trust. That way, both spouses would get the benefit of their exclusion.  However, this changed with the new tax law. The first spouse to die now uses the exclusion against assets in his estate. Any unused exclusion amounts can then be used by the surviving spouse with their own, at her death.

This would appear to simplify estate planning, for some, the use of two separate trusts will no longer be needed. However, remember these thoughts: (i) the unused applicable exclusion amount from an earlier marriage usually isn’t available, and you can use the amounts only from your last deceased spouse in your estate planning; (ii) these unused exclusion amounts aren’t indexed for inflation, so the property your spouse receives at your death may increase in value in the future, and its value could ultimately be greater than the unused exclusion; and (iii) to use portability, an estate tax return must be filed, so the estate executor must make an election to do so, by filing a return—even if the estate wouldn’t usually be required to do so.

Because of the tax law changes, estate documents drafted before 2010 may not accurately reflect your desire,s because portability and the increase in the exclusion amount can have an effect. Review the changes with your estate planning attorney.

Reference: WMUR (November 21, 2019) “Money Matters: Portability and estates”

What Will New Acts of Congress Mean for Stretch IRAs?
Retirement On Calculator Showing Pensioner Retired Decision

What Will New Acts of Congress Mean for Stretch IRAs?

The SECURE and RESA acts are currently being considered in Congress. These acts may impact stretch IRAs. A stretch IRA is an estate planning strategy that extends the tax-deferred condition of an inherited IRA, when it is passed to a non-spouse beneficiary. This strategy lets the account continue tax-deferred growth over a long period of time.

If a parent doesn’t need her Required Minimum Distributions, does it make sense to do a gradual Roth IRA conversion and use the RMDs to pay taxes on the conversion? Or should the parent invest the RMDs in a brokerage account?

There are several options in this situation, according to nj.com’s recent article, “With Stretch IRAs on the way out, how can I plan for my children’s inheritance?”

Congress is considering legislation with the SECURE and RESA Acts, that would eliminate the ability of children to create a stretch IRA, one that would let them to stretch distributions from the inherited IRA over their lifetimes.

Under the proposed SECURE and RESA Acts under consideration, the maximum deferral period will be 10 years. If the beneficiary is a minor, the period would be 10 years or age 21.

The best planning strategy for a parent would depend on her overall finances and what she wants for her children’s inheritance.

The conversion to a Roth may be a good planning move, depending on her tax bracket. Putting the money in a brokerage account is also an option.

A parent may also want to think about using the RMD proceeds to purchase a life insurance policy held by an irrevocable trust for the benefit of her children.

It’s best to contact an experienced estate planning attorney, so he or she can review the details of the parent’s finances and help her choose the best options for her situation.

Reference: nj.com (October 15, 2019) “With Stretch IRAs on the way out, how can I plan for my children’s inheritance?”