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Bad Estate Planning

Sometimes an example of a financial mistake is an easier way to deliver an important bit of advice than the usual soapbox lecture. Given the recent changes back to old style of estate taxes and the step up in basis the beneficiary enjoys, it seems timely to share this story with my readers.
The house is a four family, a small apartment house, purchased in the early 1940s when $4000 went a bit further than it does today. Owned by the grandmother, the four apartments are each occupied by family members. Well before the grandmother passed away, she quit-claims the property half to her son, the other half to her two daughters. This was the first mistake, in effect, the house was gifted, no paperwork filed, and no stepped up basis on her passing. To make matters worse, the son had since passed on, but not before transferring his half share to his daughter. His surviving spouse and daughter continue to occupy half the house, i.e. Two of the four apartments. The real issue has yet to surface. When the mom (surviving spouse) passes and the daughter wishes to sell her half along with the other relatives, there was never a step up in basis, and while she may be able to take the $250,000 exclusion on her 1/4 value she lived in, the quarter occupied by her mom is nearly all a capital gain. The current building value is about $800,000, so this woman is looking at a potential near $30,000 tax bill. Three chances to avoid it, all missed due to lack of knowledge and lack of good counsel.

As I was getting ready to publish this, I heard back from a fellow newsgroup reader;

It’s not as bad as it seems.  If the woman still lives there (or could) when she dies, §2036 says, “The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death—
“(1) the possession or enjoyment of, or the right to the income from, the property, or
“(2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.”
Then under §1014 says that a recipient gets a stepped up basis “if by reason thereof the property is required to be included in determining the value of the decedent’s gross estate under chapter
11 of subtitle B….”

It was not the smartest thing to do, but it doesn’t have to be a problem, either.

So, in the end, it’s a matter for the tax guy for the beneficiary of the house. Hopefully he has his facts straight.

{ 2 comments… add one }
  • Evan April 20, 2011, 9:17 pm

    It is a cluster when it doesn’t have to be. This is likely a situation when people tried to bypass the fee of a good attorney, by using legal zoom to create a quit claim deed without really understanding the ramifications.

    Lets say the value is brought back in the estate what about State Estate taxes? Who is going to pay those? In NJ the exemption amount is 675K, in NY it is 1mil. Not sure the state this is from.

    This all then ignores what the hell is going to happen between family members. Lets say for all intents and purposes this is a valid transfer (i.e. properly executed deed) who is being disinherited?! What if surviving spouse gets remarried? ugh

  • Darwin's Money April 21, 2011, 9:06 pm

    It’s too bad the average layperson needs to seek out and pay for complex estate planning like what you laid out but it’s true – if you have the assets (and thus can afford planning), it’s worth it in the end. As you get older, you start thinking less about what to do with your money and more about how to keep it out of the hands of the government.

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