Category : Estate Planning

Passing Real Estate to the Next Generation: Is Adding Your Child to the Deed a Quick Fix?

When planning for the future, I often hear property owners ask: Do I really need to create an entire estate plan, or can I just handle my real estate by adding my child to the deed? Adding a child to a deed may seem like a simple way to pass property to the next generation, but it can also lead to many unintended and unwanted complications. A comprehensive estate plan is often a more straightforward and, ultimately simpler, way to handle titled property.

When someone wants to add a child to a deed in order to pass the titled property to that child, the child will need to be added as a joint tenant. A joint tenant has rights of survivorship, which means that when one joint tenant dies, the property passes automatically to the other joint tenant(s) outside of probate. Sounds pretty simple, right? Unfortunately, this option is often only minimally advantageous in Maine (i.e., probate is generally simple and relatively inexpensive in Maine, there are other ways to achieve better privacy, and this option does nothing to avoid estate taxes) and can result in a number of unwanted challenges.

First, any joint tenant may sever the joint tenancy and sell his or her interest in the property to whomever he or she may wish. Do you really want your child to have the flexibility to sell his or her interest in your home while you are still living in it? Or to sell an interest in your investment property while you are still reaping the income from it? Even if you trust that your child will not sell his or her interest in the real estate, what about his or her creditors (ones you may or may not know about)? As a joint tenant, his or her creditors have the ability to attack your child’s interest in the property.

Second, your child could complicate or interfere with decisions you want to make regarding the property. For example, if you wanted to sell or refinance the property or place it in a business or trust, your child’s consent and signature would be required for all related documents in order to transfer or refinance the entire property. The requirement of your child’s signature could significantly limit what you are able to do with your property.

Third, if one joint tenant becomes incapacitated, the court may require that a conservatorship protect the interest of that joint tenant, which can lead to unintended complications. For example, if the parent becomes incapacitated, a conservator may challenge actions of the child or expect a child to cover a certain portion of the expenses, which may not have been intended by the parent(s). Likewise, if the child becomes incapacitated, the conservator could challenge the actions the parents are taking regarding their own home or their investment property, even if the intent is for the parents to receive all the benefits such as rental income from the property during their lives.

Fourth, if the property generates income, the income tax obligations will be split among the owners according to their interests. Therefore, if the parents own income-generating property and want to continue to reap the benefits of all of the income for the remainder of their lives, the child as a joint tenant is nonetheless on the hook for income taxes for his or her interest in the property.

Fifth, adding your child to a deed raises issues around gift and estate taxes. Once the interest deeded to your child (together with any other gifts for that year) exceeds the $14,000 annual exclusion, you will need to file a Form 709 indicating the value of the gift in excess of the annual exclusion. This amount will count against the total amount you are able to gift before paying gift and estate taxes. Moreover, a child will take his or her interest as a joint tenant with the same basis the parent(s) had in that interest. As the other joint tenants pass, the child will receive a step up in basis only on the interests that pass as a result of the death of the other joint tenants. The step up on each interest will be equal to the value of that interest on the date of the other joint tenant’s death. On the other hand, when the child is not added as a joint tenant, allowing the property to pass at the time of death, the child takes the entire property with a step up in basis equal to the value of the property on the date of death. This difference in basis could have a significant impact on the amount of taxes owed by your child if he or she decides to sell the property.

Sixth, because one’s Last Will and Testament does not have any impact on property held in joint tenancy (because the property automatically passes to the other joint tenants on the deed no matter what any joint tenant’s Will may state), you run the risk of unintentionally disinheriting other individuals or creating a disparity in inheritance where none was intended. This is especially true when one experiences a major life change such as divorce, the birth or adoption of a child, or a marriage after creation of the joint tenancy.

Ultimately, creating a joint tenancy can be an easy way to transfer property on death while avoiding probate with respect to that particular property. However, it is important to be informed about the issues that can arise when adding a child to a deed. An attorney can help you develop a plan that will pass your property according to your wishes.

Tamlyn M. Frederick is an estate planning attorney at Frederick, Quinlan & Tupper in Portland, Maine.

Tax Treatment of Gains on Different Types of Residential Real Estate

The tax consequences related to the sale of a residential property depend largely on the characterization of the property. For example, the sale of one’s principal residence is treated differently than other types of residential real estate. Likewise, investment properties or vacation homes held for more than a year are treated more favorably than such properties held for less than a year. Whether you are considering entering the rental market, flipping homes, or selling your principal residence, it is important to understand how each will be taxed when it is time to sell.

Primary Residence

When you sell your principal residence, you may be able to exclude from taxation up to $250,000 in gains if you are single, or $500,000 if you are married, so long as you have both owned and lived in the property as your principal residence for two out of the prior five years. This is not a one-time exclusion. It can be used over and over on different properties, so long as the two-year requirements are met each time. However, you can only have one principal residence at a time and any gains over the applicable exclusion amount will be taxed at capital gains rates. If you do not meet the two-year test for both use and ownership, the entire gain from the sale of your primary residence will be taxed at capital gains rates. It is important to note, though, that there are some exceptions to this general rule where you may qualify for a partial exclusion even if you do not meet the two-year tests.

Residential Rental Property

Rental properties add another wrinkle that differentiates them from other types of residential properties. An owner is entitled to depreciate the value of the property on his or her income taxes over the course of 27 ½ years. For example, if you buy a rental property for $275,000, you can depreciate the property at $10,000 per year for 27 ½ years such that the tax basis becomes $0. If you then sell the property for $400,000 after having depreciated the entire value of the property, you will be required to pay the capital gains rate on the $120,000 gain realized from the sale of the property and also a maximum of 25 percent (an attractive rate to individuals in higher tax brackets) on the $275,000 that was depreciated over the years.

Other Residential Property: Anything from the Vacation Home to the Fixer Upper

For all other residential property that is not your primary residence— whether it is a vacation home or a fixer upper—if you have owned the property for more than a year, you must pay tax on any profit at the capital gains rate. However, if you have not owned the property for more than a year at the time of the sale, the profit is taxed at ordinary rates.

Although taxes may not be the decisive factor when selling a piece of property, they are an important consideration since they could significantly impact the amount of money you actually collect from a particular transaction. Therefore, when making decisions to buy or sell real estate, an attorney or tax advisor can provide guidance about any timing issues and the associated tax burdens.

You Developed an Estate Plan but You Experienced a Major Life Change. Do You Need to Change Your Will?

You’ve done your homework and developed an estate plan. But then you have a major life change—a divorce, a marriage, or the birth or adoption of a child. What should you do next? It is advisable to alter your will in accordance with such a change for two major reasons. First, such an event will likely change the way you want your assets dealt with under your will. Second, even if you still wish for your will to function in the same manner as previously set forth in your will, the default rules in the Maine Probate Code may operate to alter the way your estate is administered due such a change.

What Is the Effect of a Marriage on a Pre-Existing Will?

If a decedent fails to provide for his or her spouse who married the decedent after the execution of the will, the default rules in the Maine Probate Code will impact the estate plan as follows: the surviving spouse will be entitled to the share of the estate that he or she would have received if the decedent had left no will, unless it is apparent from the will that the omission was intentional or it is clear that the decedent intentionally, in lieu of provisions in the will, provided for the surviving spouse exclusively outside the will. In other words, absent clear intent to exclude the surviving spouse from the will, the default rules of intestate succession provided by the Maine Probate Code will govern what the surviving spouse is entitled to.

The share of an estate to which a surviving spouse is entitled under the rules of intestate succession depends, in part, on who else has survived the decedent. If there are no issue (i.e., children, grandchildren, etc.) or parents surviving the decedent, the spouse takes the entire estate. If the decedent is survived by parents, the spouse receives the first $50,000 plus one-half of the remaining balance of the intestate estate. If there are surviving issue, the spouse’s share depends on whether the decedent’s issue are also issue of the surviving spouse or not. When the issue of the decedent are also all issue of the surviving spouse, the surviving spouse receives the first $50,000 plus one-half of the remaining amount of the intestate estate. On the other hand, when one or more of the decedent’s surviving issue are not also issue of the spouse, the spouse receives one-half of the intestate estate.

Because a different scheme is often desired than the default rules under intestate succession with respect to a spouse, many clients will decide to amend a will in the event of a marriage. Additionally, it is important to consider desired changes to beneficiary designations after a marriage to deal with assets that will pass outside the will.

What is the Effect of a Divorce After the Execution of a Will?

When an individual passes after divorcing but does not update a will that was executed prior to the divorce, the will shall be read as though the surviving former spouse predeceased the decedent. Assets will past to the other beneficiaries as provided for in the will. However, there are occasional instances where an individual still wishes for his or her estate plan to still include the ex-spouse. If this is the case, the plan should be so updated to reflect these wishes despite the divorce.

Although the default rules of the Maine Probate Code function to remove an ex-spouse from a will, assets with beneficiary designations are treated differently. If an individual does not intend for the ex-spouse previously named a beneficiary during the marriage on various assets, he or she needs to be sure to make those changes. Otherwise, the beneficiary designation of the ex-spouse made during the marriage could stand and the ex-spouse would be entitled to the assets. Therefore, it is important to revisit beneficiary designations promptly in the event of divorce.

What is the Effect of a Child Born or Adopted After the Execution of a Will?

If a decedent fails to provide by will for any of his or her children born or adopted after his or her will is executed, that child is entitled to the value equal to what he or she would receive had the decedent died without a will. There are, however, a few exceptions where it appears the child was intentionally left out of the will, it appears that when the will was executed the decedent had at least one child and devised substantially all of his or her estate to the other parent of the later born or adopted child, or the decedent provided for the child through a transfer outside of the will with the intent that the transfer be in place of including the child in the will.

When a decedent does not leave a will, each child is entitled to the part of the estate not passing to the surviving spouse, or the entire estate if there is no surviving spouse. The part of the estate passing to such children shall be divided per capita at each generation which means that the part of the estate in issue is divided into the number of shares of surviving children and previously deceased children of the decedent (or if no surviving children, to the nearest degree of kinship with surviving heirs). Each surviving child is entitled to one share. Then, the remaining shares for the any of the deceased children are combined and divided equally among the children of the decedent’s predeceased children.

Conclusion

Because the Maine Probate Code can function to alter your estate plan upon the occurrence of a major life event, it is important to seek the advice of an attorney in making adjustments to your will and other related documents. In fact, you should revisit all of your documents that deal with distribution of assets upon your death in order to ensure your wishes are followed.

 

Tamlyn Frederick is an attorney in Portland, Maine who practices in the field of estate planning. 

Advance Health Care Directives: Making Your Own Health Care Decisions, Even When You Can’t

When planning for the future, many individuals are so focused on how their assets will be used or eventually distributed, that they often overlook planning for their own health care in the event of their incapacity. Individuals can create a power of attorney with respect to health care, which is distinctly separate from a financial power of attorney. Because both the purpose and the parties involved are often different for a power of attorney related to health care than one related to finances, these documents are drafted separately. In fact, the Maine Uniform Power of Attorney Act does not even cover powers related to health care decisions. . . .

The Pour Over Will: When is it the Right Estate Planning Tool for Maine Residents?

Estate planning can be a daunting process at any stage of life, but planning along the way can ease the process and help educate individuals about the challenging decisions they are making. The initial planning steps can introduce clients to new terminology, strategic family decisions that need to be made, and the use of various planning tools or documents. One particular vehicle that clients may not be familiar with is the pour over will, used in conjunction with a revocable trust which is a trust created during life that is fully revocable by the individual who creates it until it becomes irrevocable on death. When facing a decision as to whether or not to use a particular planning tool, such as a pour over will, one should understand the potential advantages and disadvantages as they relate to his or her specific situation. . . .