How Does My Inherited IRA Fit into Estate Planning?

How Does My Inherited IRA Fit into Estate Planning?

The Secure Act (Setting Every Community Up for Retirement Enhancement Act) was signed into law on Dec. 20, 2019 and includes many reforms that could make saving for retirement easier and more accessible for many Americans, says CNBC’s recent article entitled “Did you know inherited qualified retirement accounts must be liquidated in 10 years? If you didn’t, you are not alone.” However, the Secure Act made a major change for beneficiaries of individual retirement accounts, inherited IRAs and 401(k) plans.

The Act requires that inherited qualified retirement accounts must be liquidated within 10 years. Therefore, if you inherit an IRA or a 401(k) plan from someone other than your spouse, it could affect your retirement savings plans or strategies to transfer wealth to future generations.

Before this, if you inherited an IRA or 401(k), you could “stretch” your taxable distributions and tax payments out over your life expectancy. However, for IRAs inherited from original owners that passed away on or after January 1, 2020, the new law now requires most beneficiaries to withdraw assets from an inherited IRA or 401(k) plan within 10 years following the death of the account holder.

Retirees whose taxable income is less than their heirs’ – which is the case for most retirees – should at least consider whether it makes sense to take a different approach if they were to draw down their qualified assets more aggressively and keep larger non-qualified account balances, their tax obligation could be far less than what their higher-earning heirs may pay in the future.

They also could make strategic withdrawals from non-qualified accounts to ensure that their rate doesn’t go up significantly. That means reaching the limits of one bracket without going into the next one.

Moreover, because their non-qualified accounts receive a step-up in basis, this would reduce their heirs’ tax burden even further. That is because the gains on these accounts are taxed based on the value when the benefactor dies.

However, it’s true that not everyone will embrace a new plan like this. You may feel like you’ve saved and invested for decades and, therefore, shouldn’t have to worry about whether your adult child must pay a bit more in taxes each year.

However, to reiterate, we’re not talking about pennies on the dollar. The stakes for some could be well over $100,000. Just as many put in place estate-planning strategies to protect more of their wealth, it’s at least worth sitting down with an estate planning attorney to consider whether it makes sense to do the same when it comes to the implications of the Secure Act.

Reference: CNBC (Feb. 8, 2022) “Did you know inherited qualified retirement accounts must be liquidated in 10 years? If you didn’t, you are not alone”

Is Your Home Your Largest Asset or Biggest Liability?

Is Your Home Your Largest Asset or Biggest Liability?

If you’re a homeowner who’s ready to retire, you’ve most likely worked to pay off the home, while dreaming of the day when you could relax and live a mortgage-free, life while enjoying the fruits of your labor. However, Real Simple’s recent article entitled “For Retirees, a Home Could Be Your Largest Asset—or Your Biggest Liability” provides important food for thought.

Signs Your Home Is Your Largest Asset. A home can be one of your biggest assets because of the equity that’s been built up. You’ll be able to pass it on to your heirs, and they get a step-up in cost basis to the current market value. This will significantly reduce capital gains taxes, if the home is later sold by your children. With that equity, you can take money out of the house in a home equity line of credit. If your 62 or older with a substantial amount of equity in your home, it can be used as collateral for a reverse mortgage.

Signs Your Home Is Your Biggest Liability. A home can be a liability when it’s worth considerably less than what you paid for it, especially if you have a mortgage. The last thing you want when you’re retiring is to be saddled with a debt that has no equity. Your home could be also considered a liability, if it falls under the category of an expense that you have to manage, such as a mortgage, homeowner’s insurance, municipal taxes, repair or renovation costs, or homeowner’s association fees.

Stay or Sell? Take a holistic approach to what you want in your retirement years and determine what importance you place on your living space. The answer to this is at the core of deciding if you need to downsize. If you decide to sell your home and downsize to something less expensive, be sure to save part of the proceeds from the home’s sale. You can use that money to fund traveling, hobbies, the cost of living, or any other project in retirement.

You should also try to be more objective in evaluating your home as an asset or a liability. Retirement-aged homeowners generally choose one of these options: (i) plan to pay off your mortgage before your target retirement date; (ii) get a reverse mortgage that pays out over a specified time period; (iii) rent out the home for cashflow or offset a monthly cash flow deficit, if you have a mortgage; or (iv) sell the home in the future.

If you decide to stay in your home, there are several ways to monetize home equity in retirement, such as needs-based government programs like property tax abatements or home improvement forgivable grant programs. As alternatives to a reverse mortgage, you could tap into loan products such as a home equity line of credit or a conventional mortgage loan.

Reference: Real Simple (Nov. 1, 2021) “For Retirees, a Home Could Be Your Largest Asset—or Your Biggest Liability”

Should You Put Your House in Your Child’s Name?

Should You Put Your House in Your Child’s Name?

One of the ways families build wealth across generations is through home ownership. Parents who can afford to give a property to children who either sell the home and distribute profits or keep it in the family have a definite advantage over generations of renters. How to transfer the home is not always straightforward. A recent article from The Washington Post titled “Don’t put your kids on the title of your home. There’s a better way for them to inherit the property” explains how to do this.

In this article, the mother placed an adult child on the deed to a home purchased some five years ago. The mom wants to sell the house and buy a smaller one nearby. The adult child has never lived in the home. The mother wants to do an 80/20 split of profits from the sale, with the child receiving the majority amount. This would push the child into a higher tax bracket, although the child says she could use the income.

The mother, despite her good will, has made a classic estate planning mistake. Was she trying to avoid probate at death, or to give the child some or all of the property?

As the homeowner, the mother may exclude the first $250,000 in profits from federal income taxes, if she was the sole owner. If she were married, that number would be up to $500,000. However, she’s not the sole owner.

When a person dies, heirs inherit real estate at its current market value. If the home was purchased for $100,000 and its worth is $500,000 when the owner dies, a child who inherits the home outright and then sells it immediately will receive about $400,000 in profits. If the house was inherited after death and then sold shortly thereafter, the IRS would say the property value is $500,000.

If someone inherits a home worth $500,000 and then sells it for $500,000, there is no profit because of the stepped-up value of the home assigned at the time of the owner’s death. However, if the estate in total is worth less than $11.7 million, estate taxes are not a concern.

Here’s the twist: if the mother and child are co-owners of the home and the mother dies, the child inherits only one-half the value of the home (and receives the stepped-up basis for the half but won’t benefit from the stepped-up basis) If the child sells the home, they won’t pay taxes on the share inherited from the mother but would pay taxes on the child’s share of the home.

If the mom bought the house for $100,000 and the mother and child are co-owners, the child would inherit the mother’s half of the property at the stepped-up basis of $500,000. When the home was sold, the mother’s half is shielded from taxes, but the child’s profit is calculated based on the difference between the purchase and sales price, or $400,000, of which their share is $200,000. They would owe taxes on the $200,000, instead of inheriting the home tax-free.

There are many estate planning and real estate tax rules making this more complicated. However, one better alternative is for the mom to put the home in a living trust, so she controls the home while she is alive, and the child can inherit the home through the trust upon her death. Talk with an estate planning attorney about how to create a living trust and how it would work to benefit both of you.

Reference: The Washington Post (Oct. 20, 2021) “Don’t put your kids on the title of your home. There’s a better way for them to inherit the property.”

What are the Worst Things to Leave in My Estate?
calculator and estate asset document representing the concept of death taxes

What are the Worst Things to Leave in My Estate?

Kiplinger’s recent article entitled “5 of the Worst Assets to Inherit” says that if you’re planning to leave an inheritance to others, you should take care in what you leave them. Some assets can cause problems. However, you can prevent problems with thoughtful estate planning and the help of an experienced estate planning attorney.

Let’s look at five of the worst assets to inherit and what you can do to help manage them before you pass away:

Timeshares. A timeshare is a long-term agreement where you get to use a vacation property. These contracts are notoriously difficult to end. If you pass away, and your children inherit the timeshare, they may be responsible for the ongoing contract costs. Allow your children to decide at your death whether they want to take over the contract. They can refuse to accept it then—even if your will left them the timeshare—by making a formal disclaimer of the asset.

Potentially Valuable Collectibles. This may be a coin collection, rare stamps, or a piece of artwork. Note that the capital gains tax rate on collectibles goes up to 28%, much higher than the maximum 20% long-term gains rate on other investments. When you die, your heirs receive a step-up-in-basis, meaning when they sell they receive tax-free what the collectible was worth on the day you die. Even so, there are some substantial risks to leaving valuable collectibles as an inheritance. One problem with collectibles is that thy may be difficult to value. If you have any valuable collectibles, tell your heirs where they’re located, their estimated value and the dealers they should work with after you’re gone, so they don’t run into trouble.

Guns. Firearms can also get complicated as an inheritance because of the amount of regulation. They aren’t the type of asset that you can simply hand over to a person without the proper registration or permit. There are a number of state and federal rules, depending on your state of residence and the type of gun.

Vacation Properties. Inherited vacation properties can be a potential financial and emotional problem, especially if you’re leaving one to multiple family members. Disagreements can arise over how often each can use the property, who owes what for the repairs, whether they should sell and whether they should buy one of them out and at what value, especially if one heirs is living far away and doesn’t want their share. Even if the siblings are on good terms, a vacation property has expenses, like maintenance, property taxes, insurance and any remaining mortgage. These costs could outweigh the value of the vacation property to your heirs. If you have a vacation home, begin these discussions early with your heirs and determine if they even want the property and, if so, can you get them to agree on the terms.

Any Physical Property (Especially with Sentimental Value). Disagreements among heirs can happen over any type of physical property, like a favorite chair or Mom’s silverware. These sentimental items can be tough to divide. Moreover, it’s harder to tell what some of these items are worth. Avoid these issues and start planning the distribution of your physical property ahead of time. It is important to be clear on who will receive what to prevent arguments.

Reference: Kiplinger (Sep. 14, 2021) “5 of the Worst Assets to Inherit”

What Paperwork Is Required to Transfer the Ownership of Home to Children?

What Paperwork Is Required to Transfer the Ownership of Home to Children?

Some seniors may ask if they would need to draft a new deed with their name on it and attach an affidavit and have it notarized. Or should the home be fully gifted to the children in life?

And for a partial gift to the children in life, where they’re co-owners, would the parent be required to complete the same paperwork as a full gift? Is there a way to change the owner of a property without having to pay taxes?

The reason for considering the transfer of a full or partial ownership in your home makes a difference in how you should proceed, says nj.com’s recent article entitled “What taxes are owed if I add my children to my deed?”

If the objective is to avoid probate when you pass away, adding children as joint tenants with rights of survivorship will accomplish this. However, there may also be some drawbacks that should be considered.

If the home has unrealized capital gains when you die, only your ownership share receives a step-up in basis. With a step-up in basis, the cost of the home is increased to its fair market value on the date of death. This eliminates any capital gains that accrued from the purchase date.

There’s the home-sale tax exclusion. If you sell the home during your lifetime, you’re eligible to exclude up to $500,000 of capital gains if you’re married, or $250,000 for taxpayers filing single, if the home was your primary residence for two of the last five years. However, if you add your children as owners, and they own other primary residences, they won’t be eligible for this tax exclusion when they sell your home.

In addition, your co-owner(s) could file for bankruptcy or become subject to a creditor or divorce claim. Depending on state law, a creditor may be able to attach a lien on the co-owner’s share of the property.

Finally, if you transfer your entire interest, the new owners will be given total control over the home, allowing them to sell, rent, or use the home as collateral against which to borrow money. If you transfer a partial interest, you may need the co-owner’s consent to take certain actions, like refinancing the mortgage.

If you decide to transfer ownership, talk to an experienced estate planning attorney to prepare the legal documents and to discuss your goals and the implications of the transfer. The attorney would draft the new deed and record the deed with the county office where the property resides.

A gift tax return, Form 709, should be filed, but there shouldn’t be any federal gift tax on the transfer, unless the cumulative lifetime gifts exceed the threshold of $11.7 million or $23.4 million for a married couple.

Reference: nj.com (June 15, 2021) “What taxes are owed if I add my children to my deed?”

When Do I File a Tax Return for an Estate?

When Do I File a Tax Return for an Estate?

In this example, Mom’s entire estate is valued at less than $20,000. This includes a mobile home worth about $12,000, which the children plan to sell.

Would the estate need to report income tax?

Nj.com’s recent article entitled “We are settling an estate. What tax returns do we have to file?” says that there are a few issues to consider.

One is the mother’s Social Security income for 2020. There shouldn’t be any income tax filing requirement, if she didn’t have any other reportable income during that year.

An individual taxpayer with income under $34,000 must recognize up to 50% of the Social Security income. Therefore, in this example, since the mother’s Social Security income was only $20,000, she would have to recognize $10,000 of income.

However, that amount of taxable income is below the individual federal standard deduction of $12,000. As a result, there’d be no requirement to file a federal income tax return for her.

There may be a tax on the Social Security at the state level.

Note that Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, and West Virginia impose state income tax on Social Security payments to at least some beneficiaries.

However, there is income on capital gains recognized on the sale of the mobile home, which must be reported on federal and state income tax returns.

The basis of the mobile home would be adjusted to the value of that property as of the mom’s date of death, if she was the sole owner of that asset.

If the mobile home is sold for more than its adjusted basis, the gain would have to be recognized and reported on that excess amount.

However, if the mobile home is sold for an amount equal to its date of death value, then there would be no gain. Used mobile homes are not high demand, so it is likely there would be no gain on the sale.

Reference: nj.com (Feb. 18, 2021) “We are settling an estate. What tax returns do we have to file?”

Handing Kids Keys to Your Home Is Never Good Estate Planning

Handing Kids Keys to Your Home Is Never Good Estate Planning

Transferring ownership of the family home to an adult child may seem like a simple approach for avoiding having the house go through probate, or even qualifying easily for Medicaid. However, this seemingly simple solution comes with many problems, including taxes and the potential for years of delay for qualifying for Medicaid. That’s the advice from the article “Don’t Give Your Adult Kids Your House” from Nerd Wallet.

There are many other ways to transfer a house to family members. Estate planning lawyers will be able to help you accomplish this, without creating extra problems for your family.

First, if you leave the house to your children in your will, which means they don’t get it until you die, they receive something called a “step-up in basis.” This means that all of the appreciation of the house that occurred during the time that you owned the house until your death is not taxed.

Here’s an example. A financial planner advises his client not to let his mother gift him the family home. She paid $16,000 for it back in 1976, and the current market value of the house was close to $200,000. None of that increase in value would be taxable if the son inherited the house. However, she signed a quitclaim to give her son the house while she was living and died shortly afterwards. The estimated tax bill was about $32,000.

Some families who realize the impact of this when it’s almost too late, scramble to give the house back to the parents. They do a last-minute deed change, before it’s too late. There isn’t always time for this.

When it comes to transferring the house, so a parent can qualify for Medicaid, there’s a five-year look back that prohibits any transfer of assets, especially of a house. That can lead to a penalty period, so the senior who needs long-term care will not be eligible for Medicaid.

Transferring a home to an adult child with financial or marital problems is asking for trouble. If the house becomes the child’s asset, then it can be attached by creditors. If a divorce occurs, the home will be an asset to be divided by the couple—or lost completely.

As for the family in the example above, the man was almost stuck paying taxes on a $184,000 gain. A tax research firm he engaged learned of a workaround, Section 2036 of the Internal Revenue Code. If the mother retained a life interest in the property, which includes the right to continue living there, then the home would remain in her estate, rather than be treated as a completed gift. The son, as executor of the estate, filed 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 less stressful and less costly ways to avoid the family home being part of the probated estate. Let an experienced estate planning attorney help your family before costly, time-consuming and stressful mistakes are made.

Reference: Nerd Wallet (April 3, 2020) “Don’t Give Your Adult Kids Your House”

The Many Responsibilities of Inheriting a Home

The Many Responsibilities of Inheriting a Home

When you inherit a home, there are three key factors to consider: the financial and legal responsibilities of the home, the tax liabilities of the home and what you’ll eventually do with the home. All of these different things relate to each other, explains Million Acres in “A Guide to What Happens When You Inherit a House.”

Let’s look at taxes first. There’s no federal tax associated with inheriting a house, but some states have inheritance taxes. For most situations, this inheritance does not lead to an immediate tax liability. When a property is inherited, the IRS establishes a fair market value for the property, which is the new basis for the property. This is a step-up basis. It is the valuation that is used to set future taxes, when the property is sold.

Capital gains are a tax relating to the profits generated from selling an asset, in this case, a house. The step up in basis means the heir only has to pay capital gains taxes, if the home is sold. The taxes will be the difference between the fair market value set at the time of the inheritance and the selling price.

If the property has a mortgage, heirs will need to know what type of mortgage it is and if it is assumable or due on sale. Most mortgage companies allow heirs to take over the payments, according to the original loan terms. However, if there is a reverse mortgage on the home, the unpaid balance is due when the person who took out the reverse mortgage dies. This usually requires the heirs to sell the home to settle the debt.

The condition of the inherited home often determines what heirs decide to do with the house. If it hasn’t been maintained and needs major work, it may be easier to sell it as-is, rather than undertake renovations. Heirs are responsible for taxes, insurance and maintenance. However, if the house is in good shape, it may make sense to keep it.

What happens when siblings inherit a house together? That can get complicated, if each person has a different idea about what to do with the house. One may want to sell now for cash, while another may want to rent it out for income. What ultimately happens to the property, may depend on how well the siblings communicate and make decisions together.

Often the best option is to simply sell the home, especially if multiple heirs are involved. Note that there are costs associated with the sale of the house. This includes any outstanding debts, like a mortgage, the cost of fixing up the home to prepare it for sale, closing costs and fees and real estate agent commissions. If there is a profit on the sale of the home from the tax basis at the time of inheritance, the heirs may need to pay short-term or long-term capital gains tax, depending on how long they held the property.

Talk with an estate planning attorney about managing the sale of the family home. They will be able to guide you, advise you about taxes and keep the family moving through the process of settling the estate.

Reference: Million Acres (December 4, 2019) “A Guide to What Happens When You Inherit a House”

Can You Explain the Concept of Step-Up Basis?

Can You Explain the Concept of Step-Up Basis?

If you inherit assets—especially real property—you need to understand the step-up in basis rules. These rules can save you a lot of amount of money on capital gains and depreciation recapture taxes.

Motley Fool’s recent article on this subject asks “What is a Step-Up in Basis?” The article explains that step-up in basis has significant implications for inherited property. When an asset is inherited because the original owner has passed away, in many cases, it’s worth more than when it was first purchased. To avoid a huge capital gains tax bill when the inherited property is sold, the cost basis of the asset is modified to its value at the time of its owner’s death. This is called a step-up in basis. Note that this only applies to property transferred after death. If a property was gifted or transferred before the original owner dies, the original cost basis would transfer to the recipient.

This is a gigantic tax benefit for estate planning, regardless of whether you go ahead and sell the inherited asset immediately or hold on to it for a time. While a step-up in basis can let heirs avoid capital gains taxes, it doesn’t allow heirs to avoid estate taxes that apply to big inheritances.

The estate tax this year is imposed on property in excess of $11.4 million per individual and $22.8 million per married couple. Therefore, if you and your spouse leave a $25 million estate to your heirs, $2.2 million of this will still be taxable, even though your heirs’ cost basis in assets they inherited will be stepped up for capital gains tax purposes.

There are many strategies that a qualified estate planning attorney can advise you on to avoid estate taxes, but step-up in basis doesn’t exclude the value of inherited property from a taxable estate all by itself.

There are two significant ramifications of stepped-up cost basis regarding inherited real estate assets. First, like with other assets, you don’t have to pay capital gains on any appreciation that occurred before you inherited the property. Selling an investment property after years of holding it, can mean a massive capital gains tax bill. Therefore, a stepped-up cost basis can be a very valuable benefit. A step-up in basis can also give you a larger depreciation tax benefit. The cost basis of residential real estate can be depreciated (deducted) over 27½ years: a higher number divided by 27½ years is a greater annual depreciation deduction than a smaller number would produce.

Estate transfers are pretty complicated, so work with a qualified estate planning attorney.

Reference: Motley Fool (November 21, 2019) “What is a Step-Up in Basis?”

If My Mom Wants to Give Me Her House, Is It Better to Inherit or Buy It?

If My Mom Wants to Give Me Her House, Is It Better to Inherit or Buy It?

Say that your mom owns a house without a mortgage, and she’d like to transfer the house to her adult son and daughter. The issue is whether it’s a better strategy to make the transfer via gift or a sale. Let’s throw in the fact that the son is a U.S. citizen, but the mom and sister are citizens of France.

Some major tax consequences need to be considered, advises nj.com in its recent post, “What happens when a non-citizen wants to transfer a home to an heir?”

First, understand that if the son, a U.S. citizen, receives a gift of money or other property from a foreign person, he may need to report these gifts on Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts.

Note the difference: this an information return—not a tax return. However, there are significant penalties for not filing it. The IRS says that U.S. persons (and executors of estates of U.S. decedents) must file Form 3520 to report:

  • Certain transactions with foreign trusts;
  • Ownership of foreign trusts under the rules of Internal Revenue Code §§ 671 through 679; or
  • Receipt of certain large gifts or bequests from certain foreign persons.

As to whether a gift or a sale is better off for the adult child and his mother, consider that the children keep the parent’s cost basis on lifetime transfers of property made by the parents.

That means that if the mom’s home was purchased for $100,000 and it now has a current market value of $250,000, the cost basis of $100,000 becomes the child’s cost basis. When you sell the property, the capital gains tax on the difference between the sale price and the cost basis—$150,000—would have to be paid.

However, if the sister and brother inherit the property, they will receive a “step up” in the cost basis. Thus, if at the Mom’s death, the property is worth $250,000 and it is sold by the child for that amount, there’s no gain on which to pay a capital gains tax.

If you’re in this situation, it’s wise is to talk with an estate planning attorney to help your family with sound planning strategies. They will be able to help work out the best possible solution.

Reference: nj.com (September 24, 2019) “What happens when a non-citizen wants to transfer a home to an heir?”