Don’t Put Yourself in Post-Death Depression

Those of us who have gone through the trials and tribulations of putting together a comprehensive and professional family revocable trust know it is an emotional experience. You don’t care to dwell on the process, but rather enjoy the peace of mind that comes from having your household in order. Then comes the day that a spouse or loved one dies, and there is no one to deal with it but you.

Unfortunately, there is a series of steps enumerated under the Probate Code that must be accomplished in order for a revocable trust to remain in good standing with the Internal Revenue Service, even if you’re not in probate court. The responsibilities of the successor trustee don’t stop upon the trustor’s death and are mandated by the Probate Code — whether you’re in Probate Court or not.

A few examples of things that must be done before you can start grieving are as follows:

» There must be signed acceptance of the trust by the trustee pursuant to P.C. 15600. However, this requirement can be fulfilled by knowingly exercising powers or performing duties under the trust instrument. In other words, if you are the survivor, you must begin to follow the instructions in the original or amended revocable trust.

» The trustee has the duty to keep the beneficiaries of the trust reasonably informed. Notice must be given within 60 days to any beneficiary named in the trust agreement, including any event amending or modifying the trust as listed in P.C. 16060.5 through 16061.7, which substantially changes the terms of the trust. Notice may be served by mail.

» No beneficiary can bring an action to contest the trust more than 120 days from the date of notification by the trustee, or 60 days from the day notification was mailed to the beneficiary within the 120-day period, whichever is later. That’s why you want to notify the beneficiaries as early as possible. Notification doesn’t have to follow a specific format, but it must give reasonable information to inform them of the event that affects them.

This would be a good time for the trustee to see an attorney and/or a CPA, if you haven’t done so already. Below are some compassionate words of advice to attorneys who undertake the administration of the trusts after a deceased spouse has been laid to rest.

There is often a “disconnect” between lawyers and grieving clients. When the attorney and client should be sitting at a round table, the client often ends up staring across a large desk between him and the attorney who is advising and doing nothing more. That desk can become the attorney’s defense mechanism to keep from getting too close to the mortality he is dealing with, because there is nothing very happy about it.

“Lawyers are counselors in the bereavement transition, whether they want to be or not. Information and guidance on procedures and requirements are only part of what the client needs. Patience, availability and willingness to take time, to listen and to explain and re-explain those procedures and requirements are essential. The practitioner must avoid the common pitfall of a professional when confronting a client’s emotion, which is to ignore it. Practitioners often find it less upsetting to treat the survivor as ‘just another client’’ in order to maintain a reserve that borders on indifference. Although most practitioners are not trained psychologists, compassion and empathy are essential when assisting the survivor and the family in a post-death administration. Most individuals who practice in this area gain professional satisfaction from guiding clients from their expectations to their objectives. This purpose can be especially fulfilled in a post-death administration” — Thomas Shaffer, The Planning and Drafting of Wills and Trusts 29 (3rd edition, 1991).

In my opinion, other than obtaining the death certificate and giving a general accounting of the property and real estate to the CPA or administrating attorney, there is only one other thing a trustee must do. He or she must contact the financial institutions to have the accounts funded into the sub-trust. If this proves too exhausting because of red tape telephone answering devices, then this duty should also go to the attorney.

The grieving survivor or trustee should let the administrative attorney take care of all those needs as far as setting up trust and funding them appropriately. In that fashion, the survivors, 99 percent of whom don’t understand the process — nor want to understand — can be free to put their new life together.

Transferring Your Parent’s House Creates A Conundrum

In the majority of cases where the parent transfers a house to their child during their lifetime, it creates a capital gains conundrum. The child receives an immediate benefit when receiving the house because the state of California does not reassess the value of the home for tax purposes on a parent-child transfer. (It doesn’t reassess on a child-parent transfer either.) Therefore, the child pays no increased property tax. But, if the child wants to sell the house their parents gifted to them, they are going to be hard hit by long term capital gains.

Suppose your parents bought a three bedroom house in 1956 for $10,000 and it is now worth $680,000. Those used to be very realistic numbers in southern California before the crisis, but helps illustrate the point. Your parents have been renting the house for profit during the last three years, and now decide to gift the house to you.

When they transfer the title to you, there will be no change in the cost basis of the house. (That is the amount your parents paid for the house in 1956.) Your parents “cost basis” of $10,000 carries over to you and therefore you pay no higher property tax on the property than they did. Your cost basis is now $10,000.

What happens if you want to sell the property? With a cost basis of $10,000, you would pay capital gains tax on an $670,000 gain after a sale for $680,000.

The federal capital gains tax brackets are complex and shifting, but as of 2008, the gain on property sold on or after May 6, 2003, is taxed at a rate over 15%, and said to be going to 20%.

The California state income tax brackets are the same as the state capital gains brackets. Therefore, a single person with a capital gain of over $40,000, and a married couple with a capital gain of over $80,000 will pay the highest rate of tax California has which is 9.3%.

The math on the property works out as follows:

$680,000 fair market value
$680,000 sale
- $10,000 cost basis

$670,000 gain
- 15% Fed. tax = $100,500
- 9.3% state tax = $62,310
____________
$162,810

You will be responsible for paying $162,810 in taxes if you sold the house at today’s fair market price. It takes many years of property tax to add up to that number and justify the loss of the step-up value you would receive if you inherited the house upon their death.

Therefore, one alternative to paying this $162,810 in taxes is to wait to inherit the property after your parent’s death. At that point there will be a “step up” of the cost basis to the fair market value of the house as of the date of death. The cost basis of $10,000 will step up to the sale price of $670,000.

If you sell your parents’ house immediately after their death, there would be no capital gains taxes on the sale, if the house did not appreciate in value from the date of death.

This would all seem a little callous if you actually put gift deferment and tax avoidance ahead of the death of your parents. But the beauty of estate planning is recognizing the financial reality of these basic tax consequences and making the best of them –- and not being rudely surprised.

For example, according to IRC 121, if a married couple has owned and occupied a house for two out of the last five years, they can exclude the first $500,000 of their capital gain from taxes. (It is $250,000 for a single person.) But they now apportion the amount of years you live in the house over the last five years.

In the scenario above, your parents could have sold the house they moved from three years ago and paid taxes using their IRC 121 exemption and walked away with a gain of $500,000 tax free.

And if a single homeowner was required to move into a nursing facility due to health reasons they can deduct the first $250,000 of capital gain if they lived in the house one out of the previous five years.

Unfortunately, this plan may be outdated by 2011 as it is rumored Congress is passinf a new estate plan law where the heir receives the cost basis and has to pay the capital dains anyway.