When Shakespeare said (spoken by a character in Henry VI) “The first thing we do, let’s kill all the lawyers,” it was actually a complement to the profession. It was suggested as a way to undermine the government, and lawyers were viewed in high regard, as keepers of the law. I was going to offer “Let’s kill all the lawyers” as a headline, but that would be awful. I don’t want to kill anyone, but I do want to offer a warning about the bad ones.
Bad doesn’t always mean malicious, it can just come from ignorance. And now, let me offer another post-mortem, how a series of lawyers messed up my sister’s finances. It took a few to mess up this badly. It started in the early 80s, when my grandmother passed away. She owned the family house, a small apartment building, 4 apartments, all occupied by relatives. After she died, I found out tat she had transferred ownership before her death, half of the building going to my father. Nearly two decades later, another lawyer helped transfer his share to my mother. No tax forms filed, no paperwork beyond the quit-claim deed filed at the registry of deeds. Since my mother and sister still lived there, no disaster just yet. I knew at that point that since the house was never inherited, the basis ($4000, bought in the 1930s) never got stepped up. I advised mom to set up an irrevocable trust, so her share could pass to my sister and get stepped up on her death. Between then and the time mom died, another lawyer took care of the transfer. Via a trust? No. Just a transfer. In my opinion, malpractice. With my mother gone, and my sister likely to sell the house, she never got a stepped-up basis. With her share worth $600K or more (this is NY, where home prices are insane) and basis so low, even at the long term gain rate, she’s looking at $110,000 in federal taxes and $63,000 in NY tax.
Please, take a moment to let that settle in. Inherit the property on death, sell it, pay $0. Get it as a gift, basis follows, pay a tax totaling $173,000. That difference would allow a withdrawal of just under $7000 per year (Using the 4% withdrawal rule).
Now, there were 2 options that were proposed to her. One, since she’s lived in the house most of her life and certainly the past 2 years, claim the $250,000 exclusion. That drops her total tax bill to $90,000. Better than $173,000, but not the zero my advice would have achieved.
The other advice? To fill out the tax return as if the house was inherited. Not my advice. And this option has the potential to really blow up. Presumably, my sister would use the proceeds to buy a condo in the area, and this would take most, if not all of the money from the house sale. Imagine, she’s all moved in, and somehow, a random audit shows she owes the full amount, but has already spent it. Not a good situation to be in.
Whether it’s a reader or a family member, there’s no joy in saying “I told you so.” What remain is my private thoughts and my own feelings that people shouldn’t offer advice when they are not knowledgable. In my world, there’s a lawyer who should be writing a large check to my sister for his bad advice.
(Disclosure – the numbers above are all accurate, I expect the house to sell for $1.2M and my sister is in for half. I am not in for any of it. I have no issue with that. I only want the best for my family including my sister and my cousins, each with their own tax issue when the house sells.)