Estate Tax

What Are the Tax Considerations When Parents Transfer a Home to Children?

When you inherit a home from your parents, there are several tax issues that need to be addressed. They differ by state. You’ll need to understand the details, so you don’t end up with a tax surprise.

When a home is transferred from a parent to a child, there is no property tax reassessment, if this takes place in California. This can lead to challenges figuring out the difference between property tax base and cost basis. This is clarified in a recent article from the San Francisco Chronicle, “Taxes on a home can be confusing: Here’s how to keep them straight.”

Couple-home-house-1288482If parents transfer their home to a child, the child can keep the current assessed value and annual property tax. The transfer can be either while the parents are living or in their will. If the transfer is an inheritance, and the child keeps the low property tax base, the child will still receive the stepped-up basis and avoid a substantial capital gain, when the home is eventually sold.

In other words, if parents give their home to their child as an inheritance, can the child have both the continued low property tax and the stepped-up basis? Yes, provided the property is transferred at the parent’s death. If it’s transferred while the parent is still alive, the child will receive the property tax break. However, he or she will not get the step-up in basis, which is a huge tax break for highly appreciated homes.

People frequently confuse “property tax base” and “cost basis,” and property taxes with income taxes. They’re entirely separate systems. Property taxes are governed by state law.Cost basis, capital gains and the step-up in basis are part of theincome tax system. For example, in California, your property tax base (known as your “assessment”) is generally what you paid for your house, plus an inflation factor not to exceed 2% a year, plus the value of major improvements. When property changes hands in California, it’s typically reassessed at current market value, which can mean a big spike in property taxes. As you can imagine, California home prices have generally increased much more than 2% a year over long periods.

Proposition 58 allows parents and children to transfer a primary residence, as well as a large amount of other property, between each other without any property-tax. This transfer can be by gift, sale or inheritance. This tax break is usually used, when a parent dies and leaves a home to a child or children. However, parents can also transfer the home, while they’re still alive without requiring a reassessment. The child can later transfer the inherited home, and its low property tax base, to their children.

Under the income tax system, the cost basis in your home (if you’ve never rented it out) is generally what you paid for it, plus the cost of major improvements. If you sell your home for more than its cost basis, the profit is taxed as a capital gain. If you’ve used the home as your primary residence for at least two of the past five years ending on the sale date, the first $250,000 in capital gains, or $500,000 for married couples, is tax free. If you retain your home until death, your heirs could receive an even greater capital gains tax break.

When you pass away with appreciated assets, including a home, their cost basis is “stepped up” to the market value on your date of death. Your heirs inherit the assets with their new, stepped-up cost basis. This will eliminate any taxes on the appreciation that happened in your lifetime. If your heirs sold these assets immediately, they’d owe little or no capital gains tax.

Unlike the property tax break, this capital gains tax break is only for inherited property. If you give your home to a child while you’re still alive, the child takes over your cost basis and loses the stepped-up basis. In addition, if you give your child all or part of the home while you’re alive, you’ll have to file a gift-tax return for the value that exceeds the annual gift tax exclusion. Although you probably won’t owe gift tax on the home’s value, it will be subtracted from your combined lifetime gift and estate tax exemption, which is $11.18 million for any person who dies in 2018, or $22.36 million for a couple.

If a married couple owns a home together as community property, and one spouse dies, the entire house is stepped-up to the date of death value. After the surviving spouse dies, it’s stepped up again.

Hypothetically, you could use the $250,000/$500,000 capital gains tax exclusion on a primary residence use every two years. There is no limit, provided you’ve lived in the home at least two of the past five years. However, there’s an exception if you bought the house as part of a 1031 exchange. That’s a federal law that allows you defer the tax due on the sale of business or investment property, if you reinvest the proceeds in another property. If the house is acquired through a 1031 exchange and you convert rental property to a primary residence, you have to live in it two of the last five years, but also own it for the last five years.

If you give a home to your children, they can use this exclusion, if they meet the primary-residence requirement. This is entirely different than a property tax break, which you can use only once. California homeowners 55 and older can sell their primary residence and transfer their property tax assessment to a replacement home of equal or lesser value. The replacement home must be in the same county as the old one (or in one of the 11 counties that accept incoming transfers). Homeowners, including their spouse, if married, can only do this oncein a lifetime. This transfer doesn’t impact your cost basis or capital gains.

There’s an interesting new law being proposed in California, which appears on the November ballot. Proposition 5 would allow seniors to transfer their property tax base to a replacement home, regardless of the price and located anywhere in California, as many times as they want. If they bought a home that cost less, their assessment would be reduced, and if they buy a pricier home, the difference in the price between the old and new homes would be added to the old home’s assessment.

Reference: San Francisco Chronicle (September 1, 2018)“Taxes on a home can be confusing: Here’s how to keep them straight”

New Tax Law Calls for An Estate Plan Review

When was the last time you reviewed your estate plan?

Don’t assume that the new tax law means that you don’t need an estate plan. If anything, you need to review your estate plan to make sure you’re not missing out on any new opportunities.

25543329453_9991c191f2_oWhen was the last time you reviewed your estate plan? If it’s been more than a few years, you could be risking making some big mistakes, in terms of taxes and what you leave behind for your loved ones.

The new tax law in effect doubles the federal estate-tax exemption to roughly $11.2 million per person. As a result, most people won’t be subject to federal estate tax. However, before you unfriend your estate planning attorney on social media, understand that the drastic increase in the federal exemption amount means that old wills and trusts may be in dire need of an update.

Kiplinger’s recent article, “Update Estate Plans in Light of New Tax Law,” notes that the 2017 tax reform gives new opportunities for estate planning techniques to reduce your taxes. You also still have the other benefits of estate planning to consider, such as creditor protection, strategies to protect against elder financial abuse, and maximizing bequests. However, remember that the new higher exemption amount sunsets at the start of 2026. That’s when the old $5 million exemption (adjusted for inflation) reappears.

For example, your estate plan may include a will and trust that applies formulas tied to the federal estate-tax exemption. With the new tax law, that could now have unintended consequences.

You should review your estate plan regularly, despite the legislative changes. That’s because life changes: your net worth changes, you or your children get married or divorced, grandchildren are born, and as a result, your old estate planning documents may not accurately reflect your wishes.

When you update your documents, remember your durable power of attorney. This type of gifting power may have made more sense when the federal estate tax exemption was much lower. However, with today’s higher exemption, broad gift provisions shouldn’t be included in some powers of attorney, because they leave seniors vulnerable to financial abuse.

The strategies that worked so well five or ten years ago when you last reviewed your estate plan, may be completely out of date. You may not need a complete overhaul of your estate plan, but if you haven’t reviewed your estate plan recently, including checking on all of your beneficiaries, you may be doing yourself and your loved ones more harm than good.

Reference: Kiplinger (April 28, 2018)“Update Estate Plans in Light of New Tax Law”

New Estate Tax Law Enacted in Maryland Not Tied to Federal Tax Rate

The state legislature of Maryland has passed a law following the new tax reform that will limit the state’s estate tax exclusion amount.

The ability of the state to set laws regarding estate taxes has been exercised by Maryland, which has put its own estate law in place, separate and apart from the IRS.

TaxThe state legislature of Maryland has passed a law following the new tax reform that will limit the state’s estate tax exclusion amount to $5 million. Recently passed legislation permits portability between spouses of the deceased spouse’s unused exclusion amounts. This lets the personal representative or executor of the deceased spouse make an election on the decedent’s estate tax return to port the deceased spouse’s unused exclusion amount to the surviving spouse.

LegiScannotes in “MD HB308” that Maryland's estate tax exclusion amount has been "de-coupled" from the federal estate tax applicable exclusion amount (known as the "estate tax exemption") since 2004. However, a law enacted in 2014 provided for the eventual re-coupling of the Maryland Estate Tax Exclusion Amount to the Federal Applicable Exclusion Amount. This was phased in from 2014 through 2019. Full re-coupling was to be effective for decedents dying on or after January 1, 2019.

In effect, the 2014 Maryland law provided that for decedents dying on or after January 1, 2019, the Maryland estate tax exclusion amount would equal the amount that could be excluded under the federal estate tax. Prior to the passage of the Tax Cuts and Jobs Act in December 2017, the indexed federal exclusion amount was scheduled to be $5.7 million in January of 2019.

 However, with the new tax reform, the federal exclusion amount was upped to $10 million per person, indexed for inflation, for decedents dying on January 1, 2018 or later, through December 31, 2025. After indexing for inflation, the per person exclusion amount will be roughly $11.18 million in 2018.

Starting on January 1, 2026, the $10 million per person federal exclusion amount will sunset and return to the prior exclusion amount of $5 million per person, indexed for inflation.

The maximum Maryland estate tax rate of 16% is not altered with the new legislation .

In addition, the state’s inheritance tax is also unchanged. That rate is based on how closely related the decedent was to the people who inherit from him or her, rather than on the size of the estate. The inheritance tax doesn’t apply to surviving spouses and the children of a decedent.

The prior 2014 law still applies to decedents who passed in 2018, so the exclusion amount remains at $4 million for them. Note that the 2014 amount is not indexed for inflation and portability between spouses is not permitted.

Every state has its own estate tax laws, so it is best to meet with an estate planning attorney in your state to map out your family’s plan.

Reference: LegiScan (April 5, 2018) “MD HB308”

Now That Same-Sex Marriages are Legal, Do They Make Financial Sense?

Every couple’s situation is different, and there are pluses and minuses for couples considering whether or not to tie the knot.

Every couple’s situation is different, and there are pluses and minuses for couples considering whether or not to tie the knot.

Bigstock-Smiling-Gay-Couple-44953600In June 2015, the U.S. Supreme Court ruled that same-sex couples had the right to marry. A 2017 Gallup poll, reported in a recent WTOParticle, “Gay and Getting Married? Financial Advantages and Disadvantages,”found that only 10.2 percent of gay couples in America have wed.

Financial implications may not be at the top of the list for gay couples deciding to marry, but, there are several to consider. Some may not be beneficial, but some are. The most significant issues for married gay couples, like married straight couples, should be retirement planning, estate planning and tax planning.

The major benefit for gay couples marrying is the survivor’s Social Security benefits. If you’re lucky enough to have a retirement plan where there is a pension benefit, it can be transferred from spouse to spouse. The other big issue is gifting: spouses can leave an unlimited amount of money between spouses. But if you’re not married, that doesn’t happen.

A major difference in what each partner makes can gum up the works, especially with the IRS. Consider the marriage penalty tax and figure out if you’re better off being married or not being married. You could be subject to not getting some of the tax exclusions that would’ve worked to your advantage, if you weren’t married. This is especially true, if there is a wide variance in income between both partners. You should also think about loss-limit deductions on things such as investment property, IRA and retirement account deductions, and other tax planning situations that can become significant considerations when one partner earns much more than the other.

When combining the income of the two spouses, it may put them both into a higher tax bracket. This will add more tax liabilities. You should also think about homeownership and retirement. For unmarried gay couples with a big variance in incomes, who own their home as joint tenants with right of survivorship, the surviving individual will get the house, when the first one passes away.  However, there could be some gift consequences, depending on how the money went into paying for the house and who put more money into it versus who didn’t.

There are also retirement accounts to look at. Married couples can pass IRAs or 401(k)s to one another at death, without triggering taxes. If you die with money in your retirement accounts, the IRS starts taxing that money as soon as your beneficiaries withdraw the money.  It also forces a withdrawal within a certain amount of time. However, there’s an exception for distributions to spouses, allowing the money to keep growing tax deferred.

You should also analyze health care. Many businesses offer health care coverage to their employees’ domestic partners. Depending on company policy for family coverage, legal marriage ensures it. There’s also a financial benefit for surviving spouses in a health saving account because that money can be transferred to the surviving spouse. Likewise, a married couple in a joint health savings account can contribute more pretax dollars.

All married couples also legally speak for each other in terms of medical decisions. Unmarried couples, either straight or gay, don’t automatically have that legal representation. For gay couples who opt not to marry, that can be solved with a medical power of attorney,an advanced medical directiveor health care proxy. These legally binding documents should be drafted, certified and available, in the event of an emergency. A power of attorney can cover both health care and financial decisions, if one unmarried partner becomes incapacitated.

When it comes to the legal and financial matters of marriage, it’s wise for all couples to meet with an estate planning attorney before walking down the aisle. You should know what rights and responsibilities come with marriage, and prepare the correct legal documents, so that you are both able to care for each other in every sense of the word, in good times and bad, in sickness and health.

Reference: WTOP (May 30, 2018) “Gay and Getting Married? Financial Advantages and Disadvantages”

Do I Have to Pay Taxes on an Inherited Annuity?

If it seems like everything is subject to an inheritance tax, well, that is often true.

Yes, there are taxes due on inherited annuities. The amount depends upon your relationship to the deceased and the value of the annuity.

TaxIf it seems like everything is subject to an inheritance tax, well, that is often true. In a recent article from nj.com, “Who pays inheritance tax on an annuity?” a beneficiary asks what happens when a Class D beneficiary inherits a qualified annuity.

In this case, which occurred in New Jersey, transfers for less than $500, life insurance proceeds, and certain state and federal pension payments are exempt. However, everything else is subject to the inheritance tax. This includes items controlled by beneficiary designations, instead of a will, like an IRA, 401(k) or annuity.

If it’s an annuity at issue, the date of death valuation must be listed on the New Jersey Inheritance Tax form (IT-R), which is for assets left to Class D beneficiaries. The personal representative (or executor or administrator) of the estate has a fiduciary duty to file the inheritance tax return (Form IT-R). The tax return, along with payment for any taxes owed, is due eight months from the date of death in that state.

The person responsible for paying the tax, depends on the deceased's will. For example, the will could state that all estate or inheritance taxes are paid out of the deceased's residuary estate, which is the part of a deceased's estate that remains after all debts have been paid and specific bequests have been distributed.

If the estate has sufficient funds to pay the tax, the beneficiaries won't owe anything.  However, the will could state that all estate/inheritance taxes are paid proportionately by the recipient, even for assets not controlled by the will. That’s the default in New Jersey, when the will doesn’t say how death taxes get apportioned or the deceased died intestate (without a will).

There can be an issue when the beneficiary refuses to pay his or her share. In that case, the executor is still obligated to pay the tax with other estate funds, if any, which will negatively affect the inheritance of other beneficiaries under the will.

In that case, the executor can sue to recover the funds from non-paying beneficiary. If the executor can't pay the tax because there aren’t enough funds in the estate, the state of New Jersey will bring a delinquency claim directly against the non-paying beneficiary.

The best course of action is simply for the beneficiary to pay their share. An executor with an uncooperative beneficiary, should speak with an estate planning attorney to explore their options and protect the estate and the executor.

Reference: nj.com (May 14, 2018)“Who pays inheritance tax on an annuity?”

Did the New Tax Law Change Roth IRA Contribution Limits for 2018?

Unlike contributions to a traditional IRA—which may be tax-deductible—a Roth IRA has no up-front tax break.

If you are 50 or older, you can put $6,500 into your Roth IRA: that includes a “catch up” contribution of $1,000. Typical Roth IRA contributions are still limited to $5,500 a year. There are income limits,  which you’ll need to be careful about.

MP900404926One good thing about the new tax law: it raised income limits to qualify for the maximum contribution to a Roth IRA.  However, the maximum contribution to a Roth IRA in 2018 is the same as 2017.

Kiplinger’s recent article on this topic asks “How Much Can You Contribute to a Roth IRA for 2018?”In its answer, the article explains that the maximum amount you can contribute to a Roth IRA for 2018 is $5,500, if you're younger than 50. Those age 50 and older can add an extra $1,000 per year in "catch-up" contributions. That is $6,500, which is the maximum contribution amount and the same as 2017.

The actual amount you can contribute to a Roth IRA is based on your income. To be eligible to contribute the maximum for 2018, your modified adjusted gross income (AGI) must be less than $120,000 if you’re single or $189,000 if you’re married and filing jointly. The contributions start to phase out above those amounts. You can't put any money into a Roth IRA once your income reaches $135,000 if single or $199,000, if married and filing jointly. Roth IRA income limits have increased slightly from 2017.

Unlike contributions to a traditional IRA—which may be tax-deductible—a Roth IRA has no up-front tax break. Money goes into the Roth after it’s been taxed. However, when you begin withdrawing funds in retirement, your contributions and all the earnings will be tax-free.

Roth’s are also more flexible than traditional, deductible IRAs. You can withdraw contributions to a Roth account anytime, tax- and penalty-free.  However, if you want to withdraw earnings tax-free, you need to be at least age 59½ and must have owned the Roth for at least five years.

Roth’s aren’t subject to required minimum distributions (RMDs) after age 70½, and you can deposit money at any age, provided you have earned income from a job or self-employment. Traditional IRAs prohibit new contributions once you reach 70½, even if you’re working.

There’s no minimum age limit to open a Roth IRA, and you can contribute to another individual's Roth account as a gift. However, the recipients must have earned income, and you can only contribute an amount up to that person's annual earnings or $5,500, whichever isless.

The popular Roth IRA accounts are used by many to leave money to heirs. Beneficiaries do have to take distributions over time, but they don’t have to pay taxes on the distributions. That’s an attractive benefit!

Reference: Kiplinger(April 22, 2018) “How Much Can You Contribute to a Roth IRA for 2018?”

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