Community Property

Estate Planning for Blended Families: The Importance of Updating Your Estate Plan

A recent Massachusetts case highlights the importance of estate planning for blended families, especially the need to update an estate plan after remarriage.

Estate Planning for Blended Families
An outdated will could wreak havoc in estate planning for blended families.

The Massachusetts Supreme Judicial Court recently unanimously ruled for the second wife of a man who demanded her share of the real estate her husband had willed to his four adult children. The Boston Globe reports in the article “SJC says spouses are entitled to part of significant other’s estate when they are left out of will” that the ruling written by Justice Elspeth B. Cypher says that widow Susan Ciani was protected by the law and has the right to cancel out the estate plan her husband approved before he died. The court held that the law was clear that “the Legislature intended for the surviving spouse to have an ownership interest in the real property for life, not merely an interest in the income produced by the real property.”

The husband, Raymond Ciani, created a will in 2000 that left his estate to his first wife, Mary. Under the will, after her death, his four children were to be sole beneficiaries of the estate, which was worth an estimated $675,000. But Mary died before her husband. Raymond then married Susan in 2013 and died in 2015 without changing his will.

After her husband’s death, Susan challenged the will in court and remained in the family home. Both Susan and the children went into Probate and Family Court and agreed to sell the family home and other assets, while judges decide who gets what.

The attorney for the four children, Maria L. Remillard, said the Court has created what could become a legal problem for blended families, because the law is obscure.

“It’s a rude awakening for a lot of people,’’ Remillard said of the law and the SJC’s endorsement of it. “It isn’t until someone passes away that the parties and surviving spouses realize the impact . . . After a second marriage, the second spouse could, in fact, totally disrupt the estate plan.”

The Supreme Judicial Court’s decision allows Susan to get one-third of the value of her husband’s real estate holdings and a similar share in the estate. If both sides had not agreed to sell the family home, Susan also would have been allowed to live there for the rest of her life.

Some states adhere to community property laws that permit a spouse to keep half ownership of all property in a marriage. However, Massachusetts follows an elective share law to protect spouses against disinheritance.

The decision emphasizes the importance of keeping your estate plan up to date, especially if you have remarried.

Reference: The Boston Globe (January 8, 2019) “SJC says spouses are entitled to part of significant other’s estate when they are left out of will”

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”

Scroll to Top