A Few Ways to Transfer Home to Your Children

November 16, 2022

There are a few ways to transfer your home to your children. Kiplinger’s recent article entitled “2 Clever Ways to Gift Your Home to Your Kids” explains that the most common way to transfer a property is for the children to inherit it when the parent passes away. An outright gift of the home to their child may mean higher property taxes in states that treat the gift as a sale. It’s also possible to finance the child’s purchase of the home or sell the property at a discount, known as a bargain sale.

These last two options might appear to be good solutions because many adult children struggle to buy a home at today’s soaring prices. However, crunch the numbers first.

If you sell your home to your child for less than what it’s worth, the IRS considers the difference between the fair market value and the sale price a gift. Therefor., if you sell a $1 million house to your child for $600,000, that $400,000 discount is deemed a gift. You won’t owe federal gift tax on the $400,000 unless your total lifetime gifts exceed the federal estate and gift tax exemption of $12.06 million in 2022, However, you must still file a federal gift tax return on IRS Form 709.

Using the same example, let’s look at the federal income tax consequences. If the parents are married, bought the home years ago and have a $200,000 tax basis in it, when they sell the house at a bargain price to the child, the tax basis gets split proportionately. Here, 40% of the basis ($80,000) is allocated to the gift and 60% ($120,000) to the sale. To determine the gain or loss from the sale, the sale-allocated tax basis is subtracted from the sale proceeds.

In our illustration, the parent’s $480,000 gain ($600,000 minus $120,000) is non-taxable because of the home sale exclusion. Homeowners who owned and used their principal residence for at least two of the five years before the sale can exclude up to $250,000 of the gain ($500,000 if married) from their income.

The child isn’t taxed on the gift portion. However, unlike inherited property, gifted property doesn’t get a stepped-up tax basis. In a bargain sale, the child gets a lower tax basis in the home, in this case $680,000 ($600,000 plus $80,000). If the child were to buy the home at its full $1 million value, the child’s tax basis would be $1 million.

Another way to transfer your home to your children is to combine your bargain sale with a loan to your child, by issuing an installment note for the sale portion. This helps a child who can’t otherwise get third-party financing and allows the parents to charge lower interest rates than a lender, while generating some monthly income.

Be sure that the note is written, signed by the parents and child, includes the amounts and dates of monthly payments along with a maturity date and charges an interest rate that equals or exceeds the IRS’s set interest rate for the month in which the loan is made. Go through the legal steps of securing the note with the home, so your child can deduct interest payments made to you on Schedule A of Form 1040. You’ll have to pay tax on the interest income you receive from your child.

You can also make annual gifts by taking advantage of your annual $16,000 per person gift tax exclusion. If you do this, keep the gifts to your child separate from the note payments you get. With the annual per-person limit, you won’t have to file a gift tax return for these gifts. If you would like to learn more about managing property in your estate planning, please visit our previous posts.

Reference: Kiplinger (Dec. 23, 2021) “2 Clever Ways to Gift Your Home to Your Kids”

Photo by Caio

IRS Announced New Lifetime and Gift Tax Exemptions

November 15, 2022

There’s big news from the IRS for people who use gifting as part of their estate planning. The IRS announced new lifetime and gift tax exemptions. The annual exclusion increased from $16,000 in 2022 to $17,000 in gifts in 2023, without needing to use up lifetime gift and estate tax exclusion or paying a gift tax. The article “Lifetime Estate and Gift Tax Exemption Will Hit $12.92 Million in 2023” from Forbes provides details.

The “unified credit,” aka the lifetime estate and gift tax exemption, will also jump to $12.92 million in 2023, up from $12.06 million in 2022. Couples may combine their exemption, so a wealthy couple making gifts in 2023 can pass along $25.84 million.

Here is another way to look at what this change means. If you’ve already maxed out on non-taxable gifts, you can give an extra $1.72 million to heirs in 2023, in addition to making $34,000 per couple ($17,000 x two) in annual gifts to every child, grandchild, siblings, niece or nephew or anyone you’re feeling generous towards.

In addition to making these generous $17,000 gifts, you can also pay an unlimited amount towards someone else’s tuition or medical expenses without any impact to your lifetime exemption. An important detail: the payments must be made directly to the school or the medical provider.

The estate tax is still 40%, but the $12.92 million per-person lifetime exemption is just one of many strategies used to transfer wealth. Others include the use of GRATs and other trusts to leverage the exemption. The bear market provides numerous planning opportunities.

Keep in mind that, while the IRS announced new lifetime and gift tax exemptions for 2023, the $12.92 million exemption is not forever. Under the 2017 Tax Cuts and Jobs Act, the lifetime exemption will sunset in the start of 2026, and the decrease will be more than half its current value.

Whether the estate and gift tax exemption will actually drop so dramatically depends on the politics of Congress and the White House and the budget and deficit pressures of the year. An early version of the Build Back Better proposal would have cut the exemption in half but did not win enough votes to pass.

Another reason to make these lifetime gifts sooner rather than later? As of 2022, seventeen states and the District of Columbia still have state estate taxes and/or inheritance taxes. For wealthy families, these exemptions can make a big difference in estate tax liabilities. If you would like to learn more about tax exemptions in your estate planning, please visit our previous posts.

Reference: Forbes (Oct. 18, 2022) “Lifetime Estate and Gift Tax Exemption Will Hit $12.92 Million in 2023”

Photo by Nataliya Vaitkevich

What Is Upstream Planning?

November 2, 2022

What is upstream planning? Estate planning with an eye to a future inheritance, known as “upstream planning,” can be especially important where families pass significant wealth from generation to generation. Knowing these details in advance can have a big impact on deciding on how to manage the heir’s own assets, as explained in the article “Expecting an Inheritance? Consider Coordinating Your Estate Plan with Your Parents’” from Kiplinger.

What happens when information is kept private? In one example, a patriarch refused to share any details, despite having children who had succeeded on their own and didn’t really need their inheritances. The family was left with an eight figure estate tax bill.

Clear and open discussions make sense. If a person has an estate large enough to need to pay federal estate taxes, inheriting more will add to their heir’s tax burdens. Parents may choose to leave assets to heirs through a trust. Money in a trust belongs to the trust, so in addition to tax benefits, the trust is a good way to protect assets from creditors, litigation, or divorce.

Trusts are also used to take advantage of the GST—generation skipping tax exemption. The executor of the parents’ estates can apply their GST exemption to the trust, which will not be taxed when they are distributed or passed to grandchildren, even if the grandchild is a beneficiary of the trust.

Business considerations also come into play. If a couple built and grew a business now being run by their granddaughter, and the grandsons have had little or no involvement, their wishes should be clarified: do they want their granddaughter to be the sole heir? Or do they want the grandsons to receive cash or other assets or any shares of the business?

Talking about multigenerational wealth early and often provides benefits to all concerned. The more money a family has, the more it makes sense to have those conversations and not only from an estate tax perspective. Those who created the wealth can use upstream planning as a way to start conversations about their success, family values and hopes for how heirs and future generations will benefit.

In some families, these conversations won’t happen because they think it’s too private or don’t want their children and grandchildren to feel they don’t need to work hard to become responsible citizens.

Communicating and coordinating are vital to success. Your estate planning attorney will be able to help you understand what upstream planning is and provide guidance; having seen what happens when upstream planning occurs and when it does not.

If you are interested in learning more about upstream planning, please visit our previous posts.

Reference: Kiplinger (Oct. 4, 2022) “Expecting an Inheritance? Consider Coordinating Your Estate Plan with Your Parents’”

Photo by Nicole Michalou

ILITS are a Common Planning Tool

October 26, 2022

Irrevocable Life Insurance Trusts (ILITs) are a common planning tool. However, buying the policy at the wrong time, leaving out Crummey withdrawal rights and ignoring administrative costs are commonly made mistakes. Being aware of these snares is important to make the ILIT effective, says a recent article titled “Irrevocable Life Insurance Trusts in Estate Planning: Common Pitfalls” from Think Advisor.

Purchasing a new policy outside of the ILIT is a commonly made error. If you purchase a new life insurance policy and then transfer it to the ILIT, the death benefit will be included in your estate for estate tax purposes if you die within three years of the transfer. This undoes any estate tax advantages of the insurance policy and the trust.

IRS Section 2035 causes estate tax inclusion for anyone who transfers or otherwise gives up power over a life insurance policy within three years of death. However, there are ways to address this. If you first establish and fund the ILIT first, so the ILIT is the entity purchasing the policy directly, the death benefit is excluded from your estate regardless of how long you live after the purchase date.

Another error concerns the “Crummy Protocol.” Unless or until the premiums on a life insurance policy are fully paid or are self-sustaining through a draw on the cash surrender value, the insured must make gifts to the ILIT to pay for the premiums. People often like to use their annual gift tax exclusion to make contributions. However, to qualify the gifts for the annual gift tax exclusion, the beneficiaries of the ILIT must have the right to withdraw certain amounts transferred into the ILIT.

Failing to include the required withdrawal rights may eliminate the ability to offset gifts by the annual exclusion right. Even if the ILIT includes Crummey withdrawal rights, you won’t be able to take advantage of the annual gift tax exclusion if the beneficiaries are not informed of their withdrawal rights each time an eligible contribution is made to the ILIT.

Your estate planning attorney will advise you as to how this occurs from a procedural perspective. While an ILIT is a common planning tool, you’ll want them to review it before it is signed to confirm it includes Crummey withdrawal rights and to help you establish procedures for providing the requisite notice and waiting the required period each time a gift is made.

Lastly, ILITs often have limited assets since they may only be funded with the insurance policy and the amount needed to pay the premiums. Therefore, if the ILIT has any administrative expenses, like accounting, legal or trustee funds, there may be insufficient assets in the ILIT to pay them.

If you pay the expenses directly, they will be considered as making a gift for gift tax purposes, because you will be deemed to have first transferred to the ILIT any amounts paid on its behalf. Avoid this issue by funding your ILIT with the necessary money to pay premiums and administrative costs. If the class of beneficiaries holding Crummey withdrawal rights is broad enough, this may be done solely through annual exclusion gifts. If you would like to learn more about ILITS, please visit our previous posts.

Reference: Think Advisor (Sep. 29, 2022) “Irrevocable Life Insurance Trusts in Estate Planning: Common Pitfalls”

Photo by Marcus Aurelius

Estate Planning should include Consideration of Income Tax

August 23, 2022

While estate taxes may only be of concern for mega-rich Americans now, in a relatively short time, the federal exemption rate is scheduled to drop precipitously. Estate planning underway now should include consideration of income tax issues, especially basis, according to a recent article titled “Be Mindful of Income Tax in Estate Planning, Particularly Basis” from National Law Journal.

Because of these upcoming changes, plans and trusts put into effect under current law may no longer efficiently work for income tax and tax basis issues.

Planning to avoid taxes has become less critical in recent years, when the federal estate tax exemption is $10 million per taxpayer indexed to inflation. However, the new tax laws have changed the focus from estate tax planning to coming tax planning and more specifically, to “basis” planning. Ignore this at your peril—or your heirs may inherit a tax disaster.

“Basis” is an oft-misunderstood concept used to determine the amount of taxable income resulting when an asset is sold. The amount of taxable income realized is equal to the difference between the value you received at the sale of the asset minus your basis in the asset.

There are three key rules for how basis is determined:

Purchased assets: the buyer’s basis is the investment in the asset—the amount paid at the time of purchase. Here’s where the term “cost basis” comes from

Gifts: The recipient’s basis in the gift property is generally equal to the donor’s basis in the property. The giver’s basis is viewed as carrying over to the recipient. This is where the term “carry over basis” comes from, when referring to the basis of an asset received by gift.

Inherited Assets: The basis in inherited property is usually set to the fair market value of the asset on the date of the decedent’s death. Any gains or losses after this date are not realized. The heir could conceivably sell the asset immediately and not pay income taxes on the sale.

The adjustment to basis for inherited assets is usually called “stepped up basis.”

Basis planning requires you to review each asset on its own, to consider the expected future appreciation of the asset and anticipated timeline for disposing the asset. Tax rates imposed on income realized when an asset is sold vary based on the type of asset. There is an easy one-size-fits-all rule when it comes to basis planning.

Estate planning requires adjustments over time, especially in light of tax law changes. This is why estate planning should include consideration of income tax issues. Speak with your estate planning attorney, if your estate plan was created more than five years ago. Many of those strategies and tools may or may not work in light of the current and near-future tax environment. If you would like to learn more about tax issues related to estate planning, please visit our previous posts.

Reference: National Law Review (July 22, 2022) “Be Mindful of Income Tax in Estate Planning, Particularly Basis”

Photo by Nataliya Vaitkevich

Dynasty Trusts offer more Control over Assets

August 15, 2022

Trusts are the Swiss Army Knife of estate planning, perfect tools for specific directions on how your assets should be managed while you are living and after you have passed. A recent article titled “This Trust Can Help You Create a Financial Dynasty” from Yahoo! finance explains how qualified perpetual trusts, also known as dynasty trusts, can offer more control over assets than other types of trusts.

What is a Dynasty Trust?

Called a Qualified Perpetual Trust or a Dynasty Trust, this trust is designed to let the grantor pass assets along to beneficiaries in perpetuity. Technically speaking, a dynasty trust could last for a century. They don’t end until several years after the death of the last surviving beneficiary.

Why Would You Want a Trust to Last 100 Years?

Perpetual trusts are often used to keep family wealth out of probate for a long time. During probate, the court reviews the will, approves the executor and reviews an inventory of assets. Probate can be time consuming and costly. the will and all the information it contains becomes part of the public record, meaning that anyone can find out all about your wealth.

A trust is created by an experienced estate planning attorney. Assets are then transferred into the trust and beneficiaries are named. There should be at least one beneficiary and a secondary beneficiary, in case the first beneficiary predeceases the second. A trustee is named to oversee the assets. The language of the trust is where you set the terms for when and how assets are to be distributed to beneficiaries.

Directions for the trust can be as specific as you wish. Terms may be set requiring certain goals, stages of life, or ages for beneficiaries to receive assets. This amount of control is part of the appeal of trusts. You can also set terms for when beneficiaries are not to receive anything from the trust.

Let’s say you have two adult children in their 30s. You could set a condition for them to receive monthly payments from trust earnings and nothing from the principal during their lifetimes. The next generation, your grandchildren, can be directed to receive only earnings as well, further preserving the trust principal and ensuring its future for generations to come.

Dynasty trusts are irrevocable, meaning that once assets are transferred, the transfer is permanent. Be certain that any assets going into the trust won’t be needed in the short or long run.

Be mindful if you chose to leave assets directly to grandchildren, skipping one generation, you risk the Generation Skipping Tax. There is no GST with a dynasty trust.

Assets in a trust are still subject to income tax, if they generate income. If you transfer assets creating little or no income, you can minimize this tax.

Not all states allow qualified perpetual trusts, while other states have used perpetual trusts to create a cottage industry for trusts. Dynasty trusts can offer more control over assets than other types of trusts, but they may not be the best choice. Your estate planning attorney will be able to advise the best perpetual trust for your situation. If you would like to read more about trusts, please visit our previous posts.

Reference: yahoo! finance (July 12, 2022) “This Trust Can Help You Create a Financial Dynasty”

Photo by RODNAE Productions

IRS Extending Time to File Portability Exemption

August 9, 2022

When a spouse dies, the surviving spouse has the option of taking the unused federal estate tax exclusion and applying it to their own estate. This is known as electing portability for the DSUE, Deceased Spousal Unused Exemption, according to a recent article “Estates can now request late portability election relief for 5 years” from the Journal of Accountancy. The IRS is extending the time it takes to file a portability exemption.

The portability exemption has grown in use, and the scheduled decrease in the estate tax exemption starting on January 1, 2026, will no doubt dramatically expand the number of people who will be even more eager to adopt this process.

The IRS has extended the amount of time a surviving spouse may elect to take the Deceased Spousal Unused Exclusion (DSUE) from two to five years. The expanded timeframe is a reflection of the number of requests for letter rulings from estates missing the deadline for what had been a two-year relief period. The overly burdened and underfunded agency needed to find a solution to an avalanche of estates seeking this relief. Most of the requests were from estates missing the deadline between two years and under five years from the decedent’s date of death.

To reduce the number of letter ruling requests, the IRS has updated the requirement by extending the period within which the estate of a decedent may make the portability election under the simplified method to on or before the fifth anniversary of the decedent’s death.

There are some requirements to use the simplified method. The decedent must have been a citizen or U.S. resident at the date of death and the executor must not have been otherwise required to file an estate tax return based on the value of the gross estate and any adjusted taxable gifts. The executor must also not have timely filed the estate’s tax return within nine months after the date of death or date of extended file deadline.

If it is determined later that the estate was in fact required to file an estate tax return, the grant of relief will be voided.

Note that this change doesn’t extend the period during which the surviving spouse can claim a credit or a refund of any overpaid gift or estate taxes on the surviving spouse’s own gift or estate return.

The decision by the IRS extending the time to file a portability exemption will become even more popular after December 31, 2025, when the federal exemption changes from $12.6 million per person to $5 million (adjusted for inflation). Given the rise in housing prices, even people with modest estates may find themselves coming close or exceeding the federal estate tax level. If you would like to learn more about the portability exemption, please visit our previous posts.

Reference: Journal of Accountancy (July 11, 2022) “Estates can now request late portability election relief for 5 years”

Photo by Nataliya Vaitkevich

Your Estate Plan should incorporate Asset Protection

July 20, 2022

Your estate plan should incorporate asset protection and tax planning. Most people don’t realize they live with a certain level of risk and it can be addressed in their estate plan, says an article from Forbes titled “You Need An Asset Protection Plan Not Just A Will.”

Being aware of these issues and knowing that they need to be addressed is step one. Here’s an illustration: a married couple in their 50s have two teenage children. They are diligent people and made sure to have an estate plan created early in their marriage. It’s been updated over the years, adding guardians when their children were born and making changes as needed. They have worked hard and also have been fortunate. They own a vacation home they rent most of the year and a small retail business and both of their teenage children drive cars. They don’t see a reason to tie asset protection and risk management into their estate plan. No one they know has ever been sued.

With assets in excess of $4 million and annual income of $350,000, they are a risk target. If one of their children were in an auto accident, they might be liable for any damages, especially if they own the cars the children drive.

The vacation home, if not held in a Limited Liability Company (LLC) or another type of entity, could lead to exposure risks too. If the property is not insured as an income-producing business property and something occurs on the property, the insurance company could easily refuse the claim if the house is insured as a residence.

If their retail business is owned by an LLC or another properly prepared entity, they have personal protection. However, if they have not followed the laws of their state for a business, they might lose the protection of the business structure.

Retirement assets also need to be protected. If they have employees and a retirement plan and are not adhering strictly to all of the requirements, their retirement plan qualification could easily be placed in jeopardy. Their estate planning attorney should be asked to review the pension plan and how it is being administered to ensure that their retirement is not at risk.

There are several reasons why tax oriented trusts would make a lot of sense for this couple. While current gift estate and GST (Generation Skipping Tax) exemptions are historically high right now, they won’t be forever.

This couple would be well-advised to speak with their estate planning attorney about the use of trusts, to serve several distinct functions. Trusts can shelter assets from litigation, decrease or minimize estate taxes when the estate tax changes in 2026 and possibly protect life insurance policies.

Estate planning and risk management are not only for people with mansions and global businesses. Regular people, business owners, and wage earners in all tax brackets, should incorporate asset protection in their estate plan to address their legacy, protect their assets and defend their estate against risks. If you would like to learn more about asset protection, please visit our previous posts.

Reference: Forbes (June 7, 2022) “You Need An Asset Protection Plan Not Just A Will”

Photo by Markus Winkler

Strategies to reduce Generation-Skipping Transfer Tax

June 29, 2022

The unified estate and gift tax exemption increased from $5 million to $10 million, with inflation indexing stands at $12.06 million in 2022. A married couple can shelter as much as $24.12 million from the federal estate tax. However, what about assets you gift or leave in your will to grandchildren, asks a recent article titled “Beware the Generation-Skipping Transfer Tax” from CPA Practice Advisor. There are strategies to reduce the generation-skipping transfer tax.

Without proper estate planning, the Generation-Skipping Transfer Tax (GSTT) may be imposed on families who aren’t prepared for it. There are some strategies to work around the GSTT. However, you’ll need to get this done in advance of making any gifts or before you die.

The GSTT was created to prevent wealthy individuals from getting too far around the estate and gift rules through generation-skipping transfers, as the name implies. A simple explanation of the tax is this: the tax applies to transfers to related individuals who are more than one generation away—that would be grandchildren or great grandchildren—and any unrelated individuals more than 37 ½ years younger. They are known as “skip persons.”

Transferring assets to a trust and naming grandchildren or a much younger person as the ultimate beneficiary doesn’t work to avoid the GSTT. If you took this route, all of the trust beneficiaries, which could also be adult children, would be treated as skip persons. Even the trust itself may be considered a skip person, in certain circumstances.

The rules for the GSTT are the same as apply to federal estate taxes. The top tax rate for the GSTT is 40%, the same rate for federal estate taxes. The GSTT also shares the same exemption rate, indexed for inflation, as the federal estate tax.

However, remember what’s coming. In 2026, the exemption is scheduled to revert to $5 million, plus inflation indexing. If Congress enacts any other legislation before then, it will change sooner.

There’s more. There is a GSTT exemption for lifetime transfers aligned with the annual gift tax exclusion. You may gift up to $16,000 per recipient, including a grandchild or other descendent, every year, without triggering a GSTT bill.

Talk with your estate planning attorney to see if these three strategies are appropriate for you to avoid or reduce the Generation-skipping transfer tax:

Make the most of the GSTT exemption. Even though lifetime transfers do reduce the available estate tax shelter, the current $12.06 million exemption provides a lot of flexibility.
You can use the annual gift tax exemption to shelter tax gifts up to $16,000 above and beyond the lifetime exemption. Use this before the lifetime exemption.
Always look to see how trusts within the usual tax law boundaries can be used to protect assets from taxes.

If you would like to learn more about strategies to reduce estate taxes, please visit our previous posts.

Reference: CPA Practice Advisor (June 3, 2022) “Beware the Generation-Skipping Transfer Tax”

Photo by cottonbro

Leaving Property in Trust is Common

May 25, 2022

A typical estate at death will include a personal residence. It’s common for a large estate to also include a vacation home, or family retreat. Leaving real property in trust is common.

Estate plans that include a revocable trust will fund the trust by a pour-over, says Kiplinger’s recent article entitled “Should You Own Your Home in Your Trust?”

A settlor (the person establishing a trust) often will title their home to the revocable trust, which becomes irrevocable at death.

Another option is a Qualified Personal Residence Trust, which is irrevocable, to gift a valuable home to a trust for the settlor’s children. With a QPRT, the house is passed over a term of years while the original owner continues to live there, so the gift passes with little or no gift or estate tax.

Some trusts arising from a decedent estate will hold the home belonging to the settlor without any instructions for its disposal or retention. Outside of very large trusts, a requirement to actually purchase homes for beneficiaries in the trust is far less common.

It is more common in a large trust to have terms that let the trustee buy a home for a beneficiary outside the trust or keep the settlor’s home in the trust for a beneficiary’s use, including purchasing a replacement home when requested.

The trustee will hopefully propose a plan that will satisfy the beneficiary without undue risk to the trust estate or exceeding the trustee’s powers. The most relevant considerations for homeownership in a trust are:

The competing needs of other trust beneficiaries
The purchase price and costs of maintaining the home
The size of the trust as compared to those costs
Other sources of income and resources available to the beneficiary; and
The interests of the remaindermen (beneficiaries who will take from the trust when the current beneficiaries’ interests terminate).

The terms of the trust may require the trustee to ignore some of these considerations.

Each situation requires a number of decisions that could expose the trustee to a charge that it has acted imprudently.

Leaving real property in trust is common and those who want to create a trust should work with an experienced estate planning attorney to avoid any issues. If you would like to learn more about managing real property in your estate planning, please visit our previous posts.

Reference: Kiplinger (Feb. 8, 2022) “Should You Own Your Home in Your Trust?”

Photo by Luis Yanez

Category: Gift Tax

A Few Ways to Transfer Home to Your Children

IRS Announced New Lifetime and Gift Tax Exemptions

What Is Upstream Planning?

ILITS are a Common Planning Tool

Estate Planning should include Consideration of Income Tax

Dynasty Trusts offer more Control over Assets

IRS Extending Time to File Portability Exemption

Your Estate Plan should incorporate Asset Protection

Strategies to reduce Generation-Skipping Transfer Tax

Leaving Property in Trust is Common

Categories

View Blog Archives

Watch the

Estate Of The Union

Join Our

eNewsletter and Blog Digest List

Listen to the

Estate Of The Union

Texas Trust Law

Quick Links

Connect With Us