Sorrell Law Blog

Welcome! Attorneys love disclaimers, and here it is:  The information on this page is intended as a general discussion of legal issues and not as legal advice. It is based upon North Carolina law and is correct as of the time it was written.The law is different from state-to-state, and is constantly changing.  It is important to review the particulars of any given set of circumstances as no two situations are identical. There may be particulars in your situation that may make critical differences. We encourage you to contact an attorney to discuss your situation.We would love the opportunity to be of service to you. But no attorney-client relationship is created by use of this material. You have not retained Sorrell Law Firm or any attorney associated with us unless you have an engagement letter signed by Richard Sorrell.

NC Case Law: RP Owner Liability

NC Case Law: Utley v Smith and Premises Liability: -or- The Danger of Collard Greens and Ice. (NC COA16-463, 12/6/2016)

After asking for and receiving directions to the collard greens, Utley tripped over some tomato crates that were staked in an aisle in the outdoor garden area of a Wake County hardware store, tomato crates that Utley had walked past earlier without incident. The question: Was the hardware store liable?

A real property owner in North Carolina owes a duty of “reasonable care” to all lawful visitors. Specifically, according to the NC Supreme Court a business owner’s duty is to “exercise ‘ordinary care to keep in a reasonably safe condition those portions of its premises which it may expect will be used by its customers during business hours, and to give warning of hidden perils or unsafe conditions insofar as they can be ascertained by reasonable inspection and supervision.’ ” Raper v. McCrory-McLellan Corp., 130 S.E.2d 281, 283 (1963). Further, NC Courts have said that an owner “is under no duty to warn invitees of obvious dangers of which they have equal or superior knowledge.” Jacobs v. Hill’s Food Stores, Inc., 364 S.E.2d 692 (1988). In Jacobs, the plaintiff tried to sue the store after falling over a concrete block in a walkway running from the store to the parking lot. The Court said that the store owner had no duty to warn of the obvious danger of the concrete block, and so was not liable for the fall. So here in Utley, the hardware store was not liable.

But it doesn’t end there, though. There may be a condition which is obvious, but which the visitor cannot deal with in any reasonably safe way. If such a condition exists on a business property, but the property is held open to the visitor anyway, the fact that the visitor is aware of the condition won’t protect the owner. The classic example is icy steps which, of course, are always dangerous even in spite of warnings. In such instances, the owner may very well be liable for harm that comes to guests/customers.

So as a business owner, it is critical to deal with such hazards either by curing them or by preventing customers/clients/guests from coming into the range of the danger.

NC Case Law: PLR IRA Beneficiary, No Do Over

Headline: In PLR 201628004 (July 8, 2016), the IRS ruled that a state court order changing a decedent’s IRA beneficiary after the decedent’s death (to cure a mistake) did not create a designated beneficiary under Code Section 401(a)(9).

Yikes…that sounds boring even to me. Yawn-o-rama. But most of us have retirement accounts. And if you do, this is actually very important.

So here is what happened: the decedent (wonderful word, decedent…so let’s call him Bob) had an IRA. In fact, Bob had two IRAs that named three different trusts as beneficiaries. Bob had the IRAs at a firm where there was a financial advisor that Bob liked and with whom he had a relationship. When Bob’s financial advisor changed firms, Bob took his two IRAs to the new firm (so that he could stay with the financial advisor). The paperwork that Bob signed to accomplish this designated Bob’s estate as beneficiary instead of the trusts. Everyone involved admits that Bob did not intend to change the beneficiaries, only to move the accounts.

When Bob died, the payment of the IRA proceeds into the Estate rather than the trusts presented numerous problems, not the least of which was a large tax bill. This was so because an estate cannot be a designated beneficiary for ‘tax stretch’ purposes. Designated beneficiary must be either an individual or one of certain types of trusts. The trusts Bob had established and had originally named as beneficiaries would have qualified as designated beneficiaries. So Bob’s heirs went to court and got an order paying the IRA benefits to the trusts as originally planned (which, again, would be designated beneficiaries under the applicable rule and so save the tax $). Some problems solved—no doubt for a considerable fee. But that still left the tax bill. And when presented with the question (trying to avoid paying the tax), the IRS ruled that the state court could not change the beneficiary for federal tax purposes, so the tax bill would be calculated as if the estate was the beneficiary.

While this was surely disappointing for Bob’s family, this was not a surprising ruling. And it reinforces what we tell our clients all the time—you can’t say it too often: It is CRITICAL that you check your beneficiary designations, and that they be what you want them to be, because there is no do-over. At least as to taxes…

Transferring Real Estate to Heirs, Part 5

One of the more frequent estate planning conversations we hear centers upon the transfer of real estate from a person to his-or-her heirs (usually children). This is the fifth and final post in a series of posts reviewing some general information on doing that. As we are typically talking about “the house”, this post will refer to “your house”, but everything here applies to any real estate.

In the previous posts we have considered what happens to property that you own with others (“concurrent interests” if you like fancy-shmancy legalisms), and we talked about leaving property to others through your will (called a “devise”), a trust, what happens if you have no will or trust, and ‘traditional’ life estates.

This brings us to a consideration of the Enhanced Life Estate. To explain this we are going to contrast it with the ‘traditional’ life estate, so reading the previous post might be helpful.

Enhanced Life Estate Deed. With an Enhanced Life Estate Deed, you could transfer the remainder to your child or to a trust that would permit greater control of the property after your death. The Enhanced Life Estate Deed is something of an innovation, a specially designed instrument that is only available in certain states, including North Carolina. It is similar to a traditional Life Estate Deed in that it is a deed that conveys property to another (called a remainderman) at death (of the life tenant). The difference is that while with the traditional life estate (WARNING: LEGALSPEAK COMING) the remainderman’s interest is vested when the deed is signed, with the ELE deed it is NOT vested until you die. In English: with the ELE your child doesn’t have anything until you die. You retain the right to change your mind. That’s right. Without your child’s consent, you can take the property back and give it to someone else. In addition, you have the right to sell or mortgage the property and keep all of the proceeds without your child’s consent. And there are no present tax implications (the IRS calls it an “incomplete gift”).

Just as with a traditional life estate, the remainderman can be one person, multiple people (in equal or unequal shares), or a trust.
PROS:
• There is no probate (with respect to the property) when you die.
• The transfer will be clear of many of the creditor problems you may develop in the future; but if you are having trouble with creditors when you make the transfer it may not protect the house from them.
• This type of transfer will not disqualify you for Medicaid (because it is an incomplete gift).
• You do not have to file a gift tax return (because it is an incomplete gift).
• The Remainderman receives a step-up in basis.
• Mortgage company approval is not required.
• Condo association approval should not be required.
• As of TODAY the property would not be available for estate recovery if you die on Medicaid. (We cannot guarantee that the law won’t change in the future. See below)

CONS:
• DMA hates these things. They have not managed to get rid of them in NC yet, but the day is probably coming. This means that if time is on your side (you have the 60 months) a trust is probably a preferable alternative.
• While your child does not have a vested interest, if your child has any income tax liens or judgment liens, they may have to be paid off before you could sell the property. There are differences of opinion on this point. Until there are court decisions resolving these issues, we must assume that the liens might have to be cleared. Many attorneys (myself included) take the position that if you can sell your property without the signature of your child, then why should you have to pay off the child’s lien in order to sell your property. If you believe that this could be an issue, you should consider the use of an irrevocable trust to serve as remainderman.
• If your child dies before you, the remainder interest goes to her or his heirs. If you are still living and have capacity to sign another deed, this can be remedied. But there is the risk that you would not be. If you anticipate that this could be an issue (e.g., “family land”), you could establish an irrevocable trust to serve as remainderman.

In conclusion, the Enhanced Life Estate Deed is an incredible tool for avoiding probate with minimal downside when compared to the non-trust alternatives, but like most such things should not be done without careful consideration of how it fits with your particular situation and goals.
QPRT. Finally, as an unexpected bonus—at no additional charge, a quick word about QPRTs. While not common in NC, they can be used here. And we have clients that come from areas where they had had past dealings with these critters. We may do a more in-depth look at these in a later post, but now a brief word.

QPRT is an acronym for Qualified Personal Residence Trust. While this could be used for Medicaid planning, its original and still most common use is for estate tax planning. If structured properly, the QPRT will freeze the value of your residence at the time you create the trust and therefore result in significant estate tax savings (because the future appreciation of the home is removed from your taxable estate). This is helpful assuming, of course, that estate tax liability is an issue and that the home will continue to appreciate. It is used much more in the Northeast, where not only are house values often considerably higher than here, but many states also impose their own estate tax in addition to the federal tax, and so the impact of the value of the house is more of an issue than here.

The method: you establish a properly-drafted QPRT and transfer your house to the trust. The Trust gives you an unqualified right to possession of the house for a set period of time (the trust term). Then comes the rub: at the end of the term you must relinquish the house (to the kids). It may be worth it, but you want to proceed cautiously after thorough analysis. The decision requires balancing the potential estate tax savings, based in part on current interest rates and the effect of the projected appreciation of the property on your overall estate, against both the consequences of relinquishing ownership to the next generation and the costs involved. The accounting may not be simple. Careful consideration should be given to both tax and non-tax consequences.

As always, this conversation is of a general nature and is NOT A SUBSTITUTE for coming in and discussing YOUR PARTICULAR SITUATION with us. We will offer you coffee, and we rarely bite. You might see a cat. Also, this conversation is based on North Carolina law at the time it was written, and assumes that both you and the real estate in question are in North Carolina.

Transferring Real Estate to Heirs, Part 4

One of the more frequent estate planning conversations we hear centers upon the transfer of real estate from a person to his-or-her heirs (usually children). This is the fourth in a series of posts reviewing some general information on doing that. As we are typically talking about “the house”, this post will refer to “your house”, but everything here applies to any real estate.

In the previous posts we have considered what happens to property that you own with others (“concurrent interests” if you like fancy-shmancy legalisms), and we talked about leaving property to others through your will (called a “devise”), a trust, and what happens if you have no will or trust.

This brings us to a consideration of Life Estates. There is the traditional life estate discussed here, and next time we will discuss the enhanced life estate.

Traditional Life Estate Deed. You could do execute a Life Estate Deed under which you retain the right to possession and enjoyment for your lifetime, and upon your death (or the death of the surviving spouse), the remainder (what is left after your life estate terminates) will pass to the child/ren (here known as the “remainderman”, whether one or more) when you die. Usually this is just called a “Life Estate”, we are calling it “Traditional” to distinguish it from the “Enhanced Life Estate” which we will discuss next time.

Life estates are quite old, and divide ownership based upon time. Person A owns until a certain named person (who may or may not be person A) dies, after that Person B owns. So I could give a house to Mary for the life of Mary, then to Susan. Susan gets the house when Mary dies, but Susan owns that part of the house NOW. (Even though Mary is alive and Susan has no right to even be in the house now.) So Susan’s interest, which is called a “remainder”, is “vested”. This will be important when we get to Enhanced Life Estates, but it also can have implications for taxes and liens.
The remainderman can be one person, multiple people (in equal or unequal shares), or a trust.

PROS:
• There is no probate (with respect to the property) when you die.
• The transfer will be clear of all of the creditor problems you may develop in the future, including Medicaid Estate Recovery. Bullet-Proof. In fact, the ONLY thing that is without using a trust. (But if you are having trouble with creditors when you make the transfer it may not protect the house from them.)
• This type of transfer will not disqualify you for Medicaid IF: the deed meets certain technical requirements AND IF EITHER a) the child or children actually pays you FMV for their interest in the property (there are tables for calculating this amount), OR b) the transfer happens MORE than sixty months before you need Medicaid.
• The Remainderman receives a step-up in basis if they receive the property when you pass away (but NOTE that if you decide to sell before you pass away they could owe capital gains tax).

CONS:
• Your child OWNS a vested future interest in your house. He or she has no present interest and can not throw you out, or even be there without your permission while you are living, but the transfer of the future interest is irrevocable (unless your child signs a deed).
• If you gift the interest (as defined by the IRS), you will probably have to file a gift tax return (though this does not necessarily mean tax would be owed).
• If there is a gift, and if you (or your spouse) need Medicaid in the following 60 months, you will face a penalty in the form of a waiting period during which you are ineligible for benefits.
• As a practical matter, you cannot sell your house without your child’s consent (signing the deed) AND, if he or she is married, the spouse signing as well.
• As a practical matter, you cannot borrow against your house without your child’s consent (signing the deed of trust and, probably, the note) AND, if he or she is married, the spouse signing as well.
• Your child OWNS a future interest in your house, so if he or she has creditor problems, the creditors may get that portion of your house (but not as long as you are alive). If this is an issue, you could establish an irrevocable trust to serve as remainderman.
• If your child has any income tax liens or judgment liens against the child’s share, they must be cleared before the property could be sold. If this is an issue, you probably should establish an irrevocable trust to serve as remainderman.
• If your child dies before you, the remainder interest goes to her or his heirs, and there will be nothing you can do about it. (Whereas with an Enhanced Life Estate, will, or trust you could change the documents.) Again, if this is an issue (e.g., “family land”), you could establish an irrevocable trust to serve as remainderman.
• If you own a condo, association approval may be required.

As always, this conversation is of a general nature and is NOT A SUBSTITUTE for coming in and discussing YOUR PARTICULAR SITUATION with us. We will offer you coffee, and we rarely bite. Also, this conversation is based on North Carolina law at the time it was written, and assumes that both you and the real estate in question are in North Carolina. Mobile homes can cause additional complications that are not addressed here. Next time, we will discuss enhanced life estate deeds and a bonus topic. Until then…

Transferring Real Estate to Heirs, Part 3

One of the more frequent estate planning conversations we hear centers upon the transfer of real estate from a person to his-or-her heirs (usually children). This is the third in a series of posts reviewing some general information on doing that. As we are typically talking about “the house”, this post will refer to “your house”, but everything here applies to any real estate.

In the last post we considered what happens to property that you own outright (as opposed to having a life estate, joint tenancy with survivorship, etc.) at your death. So we talked about leaving property to others through your will (called a “devise”), and we talked about what happens if you have no will.

1. Transfer to/through a Living Trust. You can establish a Revocable Living Trust, and then draft a deed transferring your house (or any other real estate and most other types of assets) to the Trust. Any property owned by the Trust when you pass away avoids probate. The Trust Agreement will then control what happens to the house (or anything else) when you pass away. The options are virtually limitless. You could have the trust distribute the house to one or more persons, or hold it in further trust and allow someone to live in the house. Or it could direct the trustee to sell the house and pay the net proceeds to one or more people/organizations. If the trust is property drafted, it will protect the house from your beneficiary’s creditors and unhappy spouses. (This sort of trust will NOT protect the house from your creditors.) Note: Unlike some other states, it is NOT enough merely to draft a trust agreement that mentions the house or a declaration of trust. In North Carolina, there MUST be an ACTUAL DEED that transfers the house into the Trust.

PROS:
• During your lifetime you are free to do anything you like.
• You decide who gets your house, subject to certain claims of creditors, maybe your spouse, etc.
• Your heirs (beneficiaries) get a step-up in tax basis when they inherit the house.
• If your heirs (beneficiaries) are your spouse or children and there is a mortgage on the house when you die, they don’t have to pay off the mortgage immediately, and they do not have to assume it; but they do have to keep it current.
• The house is protected from most of the creditors of your beneficiaries (if trust agreement is properly drafted).
• The house is protected from the unhappy spouses of your beneficiaries (if trust agreement is properly drafted).
• There is generally almost zero risk of litigation (if trust agreement is properly drafted).
• Very economical and easy after your death.
• It is a private arrangement, as opposed to probate, which is public.
• If there are to be multiple beneficiaries and you anticipate that they may not get along, this allows the Trustee to deal with the property without the necessity of forging agreements.
• Lends itself well to complex arrangements (if such are needed).
• Allows for genuine long-term control of the property after you pass away.
• You can transfer mortgaged property to your Trust without the approval of the mortgage company.
• If you are married, North Carolina law now allows you to maintain the protections of TbyE even though you have transferred the property to your Trust.

CONS:
• Subject to the claims of your creditors.
• The initial cost will be higher than for a will or a deed, though the long-run cost will likely be less than the use of a will.
• If poorly done, it can really make a mess of things.

2. Transfer to/through an Irrevocable Trust. You could establish an Irrevocable Trust, and then draft a deed transferring your house (or any other real estate and most other types of assets) to the Trust. There are many different sorts of Irrevocable Trusts and they vary greatly. But as a general rule, one big “pro” will be added to the list of “pros” for a Living Trust. It is this: that as a general matter the property in the Trust IS protected from your creditors. (There are some important exceptions to this.) But all good things come at a price, and the price here is a big “con” that is added to the list of “cons” for a Living Trust. It is this: loss of control. That is right, once you transfer property to an irrevocable trust there is NO getting it back. And there is a second con: since the ability to modify an irrevocable trust is quite restricted, if it is not done right the first time there may well be no fixing it.

3. Transfer to/through an LLC or Corporation. Many of our clients own rental or business real estate in an LLC or a Corporation. So the name on the deed is not a person, but is the name of an LLC or Corporation. This means that the specific piece of real estate is not an asset to leave to someone, because it is owned by the LLC or Corporation. But your interest in the LLC or Corporation IS AN ASSET that you leave to your heirs. They do get a step-up in basis in the value of the LLC or Corporation upon your passing. If there is concern that the prospective heirs won’t get along, you can make the LLC subject to an Operating Agreement (or the shares in the Corporation subject to a Shareholders’ Agreement) to facilitate the smooth transition. If you have a Trust, and you have transferred ownership (or equitable ownership) to the Trust, and the Trust is properly drafted, this should not be an issue.

On a related note: The setting up of Partnerships to own real estate used to be quite common. (LLC law was relatively undeveloped and many did not think the LLC a credible option. Also, and this may be a surprise to you, but attorneys as a group tend to be creatures of habit and are rather biased against new things.) We still see quite a few Partnerships. Upon a quick glance, Partnerships can look like an LLC (they share the trait that they don’t pay taxes but pass profit and loss directly to the owners to pay the tax). But Partnerships are not the same as LLCs. Partnerships are very prone to big and expensive problems when a partner dies. If you have one in NC, and can’t explain why it should be a Partnership and not an LLC, come talk to us. (Some states do not give LLCs favorable tax treatment, and the level of protection provided by an LLC varies greatly between states. If you are not in NC, talk to someone in your state about your needs.)

As always, this conversation is of a general nature and is NOT A SUBSTITUTE for coming in and discussing YOUR PARTICULAR SITUATION with us. We will offer you coffee, and we rarely bite. Also, this conversation is based on North Carolina law at the time it was written, and assumes that both you and the real estate in question are in North Carolina. Mobile homes can cause additional complications that are not addressed here. Next time, we will discuss life estates. Until then…

Transferring Real Estate to Heirs, Part 2

This is the second of about four blog posts that addresses ways to transfer ownership of real estate to your children. This is one of the more frequent estate planning conversations we engage in. There is a lot of bad information out there on the topic. These posts form a brief primer of the current options in North Carolina.

In the last post we considered giving your property outright to your children now, and transferring a partial interest to them now as joint tenants. Today we look at “devises”. Devise is an old-time legal word for a transfer of real estate at the death of an owner by will or intestacy. There are two ways that devises happen:

1. Transfer by intestacy (a.k.a. do nothing). If you die owning your house ‘in your name alone’ and with no will (called dying “intestate”), North Carolina’s intestacy statute will determine who owns your property after you pass away.

PROS:
• Your heirs get a step-up in tax basis (though there are better ways of doing this).
• If your heirs are your spouse or children and there is a mortgage on the house when you die, they don’t have to pay off the mortgage immediately, and they do not have to assume it, but they do have to keep it current. (Again, there are better ways of accomplishing this.)
• Free today.

CONS:
• May be very expensive tomorrow.
• There may be a substantial risk of challenge, depending upon your personal situation. Specifically, there could be litigation to determine which people qualify as your heirs, and in what percentages.
• The transfer is subject to the claims of creditors (your creditors could force your heirs to sell the house to pay them).
• May require probate administration (to determine heirs or clear creditor claims).
• WILL require some court administration to sell within three years of your death (must run Notice to Creditors).
• Heirs may lose the property to creditors.
• If your house has a mortgage, your heirs get a house with a mortgage.
• Your heirs may not be who you think they are. (Many people assume that their spouse “automatically inherits everything”. This is often not true.)
• If any of your heirs are minors, or incapacitated, the house cannot be sold with a special proceeding being brought in Superior Court.
• If any of your heirs are married, and the spouse(s) of the heir(s) will not cooperate, there could be big (read: expensive) problems.
• If your heirs have judgments against them, the judgments attach to the real estate upon your death.

2. Transfer by will. So instead of dying intestate, you could draft a will. (A person that dies with a valid will is said to die “testate”.) This conversation will presume that the will is properly drafted and executed, and can be admitted to probate.

You can draft a will leaving your house to anyone you wish. However, if you own the house as tenants-by-the-entireties and your spouse outlives you, OR if you own as joint-with-right-of-survivorship (JROS), what your will says does NOT matter—your spouse (or the joint tenant if JROS) get the property (subject to any liens on the house, of course). But Note: Even with a will, if you are survived by your spouse your surviving spouse has claims against your property EVEN IF your will ‘disinherits’ him or her. Obviously this can be a major issue. It stems from the fact that surviving spouses have statutory rights with regard to the estate of their deceased spouse, which the deceased spouse’s will does not change.

Further Note: The fact that your will says that the house is to be sold and the money divided does NOT mean that your Executor can do this. Such a provision requires VERY specific language to be in the will (in North Carolina), and we see MANY wills that have such a provision but do not have the necessary language to make it happen.

PROS:
• You decide who gets your house, subject to certain claims of creditors, your spouse, etc.
• Your heirs get a step-up in tax basis when they inherit the house.
• If your heirs are your spouse or children and there is a mortgage on the house when you die, they don’t have to pay off the mortgage immediately, and they do not have to assume it, but they do have to keep it current.

CONS:
• There is a certain risk of challenge. The degree of that risk depends upon various factors, most of which relate to how well your will is drafted and your personal situation.
• The transfer (called a “devise”) is subject to the claims of creditors (because your creditors could force your heirs to sell the house to pay them). In short, your heirs may lose the property to your creditors.
• Your heirs could lose the house to their creditors.
• May require probate administration.
• WILL require some court administration if your heirs wish to sell the house within three years of your death (must run Notice to Creditors).
• If the heirs won’t get along, or any of them are minors, or incapacitated, or have spouses that may not cooperate, or have judgments entered against them, it is important that the will give someone the power to sell, which requires VERY specific language, otherwise litigation may result.

In the next couple of posts we will consider transferring your house to/with a trust, and various life estate options. Until then…

Transferring Real Estate to Heirs

One of the more frequent estate planning conversations we hear centers upon the transfer of real estate from a person to his-or-her heirs (usually children). There is a lot of bad information out there on the topic. So this is the first of about four blog posts that will address this issue. Together, they form a brief primer based upon the current climate in North Carolina. As we are typically talking about “the house”, this post will refer to “your house”, but everything here applies to any real estate located in North Carolina (unless otherwise noted).

As always, this conversation is of a general nature and is NOT A SUBSTITUTE for coming in and discussing YOUR PARTICULAR SITUATION with us. We will offer you coffee, and we rarely bite. Also, this conversation is based on North Carolina law at the time it was written, and assumes that both you and the real estate in question are in North Carolina. There are options not covered here, these are the most common. Mobile homes can cause additional complications that will be briefly mentioned in one of the later posts.

The first transfers we will consider involve giving a present interest in your house to your children.

1. Outright Transfer to a Child (or Children). Many people decide that they will “go ahead and give our house to our kids” with the idea that this will “protect it from the nursing home”. If you transfer title to your home to a child (or children), the child (or children) owns the property. This is a gift. There will be no probate when you die, of course, because they already own it. And that means that the nursing home won’t get it when you die (assuming you don’t already owe them money), because it is not there to get. Remember that any transfer of real estate that does not clear (pay-off) liens already on the real estate is still subject to those liens, so if there are judgments or mortgages they go with the property.
But the nursing home isn’t as much of an issue as is Medicaid. If you don’t pay the nursing home, they throw you out. So people go on Medicaid, but people who just gave away a house are denied. So there are problems with this approach.
And there is another issue. You need a place to live, and giving your house away (even to your kids) complicates that. Sometimes doing this makes sense (I suppose…), but there are HUGE potential problems that should make you think twice before putting title in the name of your child.

PROS:
• There is no probate when you die.
• The transfer is clear of creditor problems you may develop in the future, but if you are having trouble with creditors when you make the transfer it may not protect the house from them.
• Deeds are cheap.

CONS:
• Your child OWNS your house. He or she can throw you out.
• Your child OWNS your house, so if he or she has creditor problems, the creditors may get your house (and throw you out). If he or she files bankruptcy, the bankruptcy trustee could sell your house (and throw you out). If your child gets divorced, your house could be lost to the now ex-spouse (who could throw you out). If your child does not outlive you, you will have problems. Your child’s heir (or creditors) will own your house (and throw you out). Picking up on a theme?
• If you have a mortgage, they may have to agree to the transfer in writing. They likely will not, but even if they do they will probably charge you a fee.
• If you are in an age-restricted community, the transfer may be prohibited by the covenants.
• If you are presently receiving property tax discounts that are offered to certain elderly or disabled citizens (that fall below certain income levels), you will no longer qualify for these discounts.
• When you give your children your house, you also give them your basis. This means that they are likely to have a capital gains tax bill in their future.
• This is a gift, so you will probably have to file a gift tax return (though this does not necessarily mean tax would be owed).
• This is a gift, so if you (or your spouse) need Medicaid in the following 60 months you will face a penalty in the form of a waiting period during which you are ineligible for benefits.
• Did I mention that if you do this your child owns your house?

2. Create a Joint Tenancy with Survivorship with a Child (or children). If you transfer title to a child (or children), the child (or children) owns the property. So rather than your kids owning the whole house, they have a partial interest (called a “concurrent interest”). You keep your foot in the door. Merely “putting their name on the deed” isn’t enough, as that would create a tenancy-in-common. The deed must clearly create a joint tenancy. And since not all joint tenancies have the right of survivorship, it must specify that as well. Note that if you own your house in a joint tenancy with right of survivorship, the deed—and NOT your will, controls what happens to the house when you die unless you are the last person whose name is on the deed to die.

This could be done as a gift (your child doesn’t pay you for the interest). Or they could pay you for it (which, if done right, will generally maintain your Medicaid eligibility). Either way, there will be no probate when you die (related to the house), of course, because of the survivorship clause in the deed. Any transfer of real estate that does not clear (pay-off) liens already on the real estate is still subject to those liens, so if there are judgments or mortgages they go with the property. Sometimes doing this does make sense, but it should not be done without careful examination of the consequences. In general:

PROS:
• There is no probate (with respect to the property) when you die.
• The transfer will be clear of many of the creditor problems you may develop in the future; but if you are having trouble with creditors when you make the transfer it may not protect the house from them.
• This type of transfer will not disqualify you for Medicaid IF: the deed meets certain technical requirements AND if the child or children actually pays you FMV for their interest in the property (so if you sell your child a 1% interest, he or she must pay you 1% of the value of the property, and you must be able to prove this actually occurred).

CONS:
• Your child OWNS a present interest in your house. He or she can not throw you out, but you cannot throw him or her out, either.
• Your child OWNS a present interest in your house, so if he or she has creditor problems, the creditors may get that portion of your house (and cause your grief). If your child files bankruptcy, the bankruptcy trustee could cause your grief (though they could not take your portion of the house). If your child does not outlive you, it did not work.
• If you have a mortgage, they may have to agree to the transfer in writing. They likely will not, but even if they do they will probably charge you a fee.
• If you are in an age-restricted community, the transfer may be prohibited by the covenants.
• If you are presently receiving property tax discounts that are offered to certain elderly or disabled citizens (that fall below certain income levels), you will probably no longer qualify for these discounts.
• If you GIVE your children a joint interest in your house, the part you gave them comes with your basis. The part they receive when you die gets a step-up in basis. How big a deal this is depends upon the numbers involved.
• If you SELL your children a joint interest in your house, the part you sell them has a basis that is the amount paid that they paid you. The portion of the property they receive when you die gets a step-up in basis. If you sell them an interest for less than FMV, the IRS will call the difference a gift.
• If there is a gift (as defined by the IRS), you will probably have to file a gift tax return (though this does not necessarily mean tax would be owed).
• If there is a gift, and if you (or your spouse) need Medicaid in the following 60 months, you will face a penalty in the form of a waiting period during which you are ineligible for benefits.
• As a practical matter, you cannot sell your house without your child’s consent (signing the deed) AND, if he or she is married, the spouse signing as well.
• As a practical matter, you cannot borrow against your house without your child’s consent (signing the deed of trust and, probably, the note) AND, if he or she is married, the spouse signing as well.

The outright transfer actually gives your whole house to someone else. There are three common form of concurrent interests. One is joint tenancy, discussed above. The second is tenancy-by-the-entireties, which is only available to married couples. It is a really big deal, and we will discuss it in a future post.

The third is the tenancy-in-common (TIC), which is very common. Unlike joint tenancy, a TIC creates an absolute ownership of ‘part’ of the property. It is like the Brady Bunch episode where Peter and Bobby divide their room with tape. Bobby gets half the room, Peter gets the other half. If Peter dies, Bobby still only has half the room—Peter’s heirs (or creditors) now have the other half. So we are not really discussing that form here, because from an estate planning and creditor protection standpoint it only creates more problems.

More in the next post…

2016 Estate Tax and the Presidential Candidates

One of the frequent topics around these parts involves the estate tax. There is nothing new here: taxes on the transfers of wealth date back to ancient Egypt. Pyramids don’t come cheap. And Caesar Augustus taxed transfers on death, though he made an exception for transfers between certain close family members.

These taxes can have odd effects. Similar taxes in the late Middle Ages were one of the forces that resulted in the Church owning a large percentage of the land in Europe by the time of the Reformation. Later in England, when a handful of families controlled most of the land, these taxes had the effect of breaking up these large estates and make what we would recognize as ownership of real estate possible for many more people (and ushering in modernism). In the United States, the similar taxes were among the tools used to break up the monopolies held by people like Carnegie, Rockefeller, and Morgan.

And—oh, yes, it was also a revenue source in all of the above cases… One thing all governments throughout time and space have had in common: a thirst for other-people’s wealth.

The estate tax as we have it dates to 1916. It was substantially reshaped during the 1970s, when exemptions for gift and estate taxes were combined in a 1976 bill that resulted in the unified gift and estate tax system we have today. (Prior to 1976 there were two separate tax-schemes, one gift and one estate, which resulted in numerous loop-holes.) The result of the 1976 bill is a genuine wealth transfer tax: the federal government limits the amount of wealth that you can transfer without being taxed (called the “unified credit”), subject to certain exceptions. It does not matter whether you transfer the wealth during your lifetime (a gift) or when you die (through your estate). Furthermore, if you sell property to a family member for substantially less than fair market value the government will call the difference a gift, and count that against your credit.

So the credit amount becomes a key to proper estate planning (though not the only one). Today, the credit amount (which, again, is the amount you can pass to others without paying the tax) is $5.45M (2016). The two presidential campaigns have different views on this. The Trump campaign wants to eliminate the tax (on the federal level). The Clinton campaign wants to drop the credit to $3.5M, and raise the tax rate from 40% to 45%. Of course neither of them can accomplish this in isolation, tax bills originate in the House of Representatives. But it is an indication of their thinking. And it is an indication of something else—you recall the old saying “Two things are certain: death and taxes.” It was not that long ago that many well-intentioned advisors were telling people that they really need not worry about the estate tax—“look how high the exemption is!”. Well, today. But maybe not tomorrow. And in terms of effect it is really not very high, but that is a different post. The point is that you cannot simply disregard the estate tax. Even if repealed, it could come back with one vote. It has before, it will again. And failure to plan for that reality creates real problems: The tax is a tax on wealth, but it is paid out of income. Depending upon the nature of one’s estate and assets, this can create an insurmountable burden for those you leave behind. Which is why planning is so important…

So the point of this post is not that you should vote for Clinton so that American wealth isn’t locked up in a few families. The point is not that you should vote for Trump because estate taxes have bad effects. The point is not that you shouldn’t vote for either one of them because they are both full of corn flakes. The point is that you should plan for what will happen when you pass away, and then review the plan periodically based upon changes in your life circumstances, the life circumstances of your prospective heirs, and changes in the law. And you should not count on any relevant factor remaining static; things change and estate plans need to be fluid. The only thing that doesn’t change is that things change. So formulate your goals, and then let’s work together to help your family accomplish them.

Lump Sum Vs. Guaranteed Income: Why Make Payments to Beneficiaries?

Often, when establishing a trust, rather than giving them a lump sum, it is desirable to have the trust make payments to one person for a period of time (called a “lifetime beneficiary” or a “payment beneficiary”), setting up a guaranteed income stream, and then after that to give what is left to another person (called a “remainder beneficiary”). Two common examples: make payments to my spouse for the rest of her/his life, then split what is left equally between my kids. Or, make payments to my kids for the rest of their lives and then give the balance to my grandkids or to charity.

Why use a Unitrust?

A Unitrust is one mechanism for doing this, and a good one. But there are others. I wrote recently about the advantages of a Unitrust . Our question here is: Why would you want to do this (make payments to beneficiaries) in the first place?

With a Spouse: When the recipient of the lifetime payments is the spouse, usually the reasoning is fairly straight-forward.
• The spouse may have assets of his-or-her own. Regardless the guarantee of a payment stream, perhaps along with lifetime rights to live in a house, will assure the comfort of the spouse for the rest of her or his life.
• Additionally, the Trustee may well have discretion to make additional payments if needed. But the main corpus of the trust is protected for later beneficiaries (usually children).
i) There is no worry that it will be lost to creditors of the surviving spouse.
ii) There is no worry that if the spouse remarries that the assets, or a portion of them, will be lost.
iii) There is no worry that the assets will be depleted in the event of a major illness.
iv) And, of course, there is no worry that the surviving spouse will ‘rewrite the estate plan’ to leave the assets to others (whether willfully or due to manipulation). This concern is more acute with later-in-life marriages.

With Kids: When the recipients of the lifetime payments are the children, some of the issues are similar but many may be different. They may include:

1. Protect from spouses. By holding the corpus in trust and making payments to your child, you insure that if your child should later divorce that the corpus of the trust will not be available for distribution in the divorce. Your child will still have his or her inheritance.

2. Protect from creditors. The portion of the inheritance still held in trust is generally not available to pay creditors who obtain a judgment against your child.

3. Protect from sickness. If your child should become terribly sick, the corpus of the trust is not vulnerable to costs for care. This allows the use of public benefits to assist with care, and the Trustee can supplement the care from the trust. This will result in a much better overall quality of care than simply depleting the assets and being broke.

4. Protect from heirs themselves—behavior issues. Sadly, some people simply hit rough patches in their lives and get involved in self-destructive patterns. Whether gambling, alcohol, drugs, or something else awful, the last thing you want to do is finance the problem. Not only can the trustee see that this does not happen, but there will be something left for better days.

5. Protect from heirs themselves—spendthrift issues. It is well known that lottery winners file bankruptcy at a greater rate than the general public. Frequently people just don’t deal well with ‘found money’. Many people, upon receiving a (to them) large sum of money, proceed quickly to spend a large sum of money. Sometimes this is nothing more than willful, flagrant spending. Sometimes a more insidious irresponsibility or even naiveté. Whatever the reason(s), the money is quickly gone with little to show for it. Likely not what you worked and saved for.

6. Protect from heirs themselves—incentive to work. Sometimes we will see people respond to an inheritance by taking a little time off. Like a few years. Why work when you can live off of the savings of someone else? Related to the former point, it is important to think about what your child may do if coming into what they may receive, and the effect it will have upon them.

7. Protection of the heirs themselves—guaranteed income for life. Simply put, you can guarantee—as much as anything in this life can be guaranteed—that your child will have income for life. And it may not be enough income to live off of, but that may be a good thing too. How much difference would another $1000.00 a month make to you? How much difference would it have made back when things were tight?

8. Stretch the benefit/value of inheritance. This is more of a big-picture thing. You are looking at the overall family-picture. You are forcing the assets to be saved. They will be (presumably) invested, meaning that they will generate income. So while payments are being made, which deplete trust assets, income is being generated to replace trust assets. The payments are offset, at least to some extent, by growth. So kids can have payments for the rest of their lives, and the balance can go to grandkids, charities, or some combination.

The idea of a trust making payments to a surviving spouse, especially in a second marriage, is really a pretty good idea. The idea of a trust making payments to your children may or may not work well for children and your situation. But it is something to at least consider in determining what is to happen after your passing.

The Advantages of a Unitrust

Often, when establishing a trust, it is desirable to have the trust make payments to one person for a period of time (called a “lifetime beneficiary” or a “payment beneficiary”) and then after that to give what is left to another person (called a “remainder beneficiary”). Two common examples: make payments to my spouse for the rest of her/his life, then split what is left equally between my kids. Or, make payments to my kids for the rest of their lives and then give the balance to my grandkids. There are numerous advantages to such a plan, which are discussed elsewhere. This is about how to do it. And historically, the payment beneficiary would receive “income” from the trust or, if that was thought to not be enough, income plus a certain amount.

But when payments are being made like this, there is an inherent tension between the interests of the current payment beneficiary and the remainder beneficiaries. The payment beneficiary wants aggressive investing, to yield (at least, potentially) the maximum growth and therefore the maximum income. The remainder beneficiary doesn’t get the income, so he or she doesn’t care about growth, safe investing is what counts. This generally provides less income but helps to ensure the maximum corpus being left to them (because significant investment losses are unlikely).

Enter the Unitrust. The Unitrust varies the traditional model by stipulating that, rather than making the payment beneficiary’s payment based upon trust income, the payment beneficiary receives a payment each year that is a set percentage of the trust balance (technically the Net Asset Value (NAV)) on a given day of the year (usually January 1st) Of course, though the payment is calculated on an annual basis, it could be (and usually is) set up to be paid quarterly or monthly.

So, for example: The trust specifies payment to the surviving spouse of 5% of the NAV annually, remainder to the children. The trust has $500,000.00 on January 1st of a given year. The surviving spouse would get a payment of $25,000.00 ($2,083.00 per month) that year, and the trust might well actually grow over the course of the year (if income less expenses is greater than 5%). This means that the spouse would get a greater payment next year. Meanwhile, the trust balance cannot be lost to nursing home care, creditors, changes in estate planning, or anything else, and may actually grow depending upon the payment level chosen by the person forming the Trust and investment choices made by the Trustee.

Now the payment beneficiary and the remainder beneficiary are both benefited, at least to some degree, by trust growth and harmed by trust loss. Both have an incentive to monitor trust investments and the activity of the financial planning of the Trust. There is still a tension between the payment beneficiary and the remainder beneficiary. But the tension is now reduced to the percentage that the payment beneficiary is to receive, and this is set by the person forming the Trust.

So what should the payment be? That will depend upon your circumstances and goals, but a common starting point for the discussion is 6%. That accomplishes a number of objectives:

1. 6% of the NAV will usually, over the course of time, cause costs and payments to the payment beneficiary to match the income generated from a balanced portfolio. (Balanced portfolios are desirable methods of insuring that the trustee is properly discharging its fiduciary duty to both the income and remainder beneficiaries.) Of course, this depends a little on costs (tax prep, paying investment advisors, etc.) and depends upon market conditions (hence, ‘over the course of time’).

2. The trustee is freed from the artificial restraints of having to invest for income or growth and can follow both the “Prudent Investor Rule” and “Modern Portfolio Theory” which means that a diversified portfolio is created based on a predetermined appropriate risk tolerance, which minimizes the risk of losing value to inflation or to market declines, and lessens exposure on the part of the Trustee.

3. Both the lifetime and remainder beneficiaries are hoping for the same result, an increased portfolio value, because the larger the growth, the greater the 6% payout becomes and the greater the remainder becomes.

4. This is a really important concept in those cases where a lifetime beneficiary can be expected to live (and take payments) for several years because over that length of time an interest oriented portfolio would, in times of modest inflation, see the value of the income decline dramatically. But the Unitrust naturally keeps up with inflation with increasing annual payouts while the principal also grows.

Of course, it may be desirable to direct more of the trust balance to the payment beneficiary (at the expense of the remainder beneficiaries) or to preserve more for the remainder beneficiaries (at the expense of the payment beneficiary). An additional consideration is whether or not the Trustee has discretion to make additional payments to the payment beneficiary if the payments are not adequate at some point (often done if the payment beneficiary is a surviving spouse or disabled). So, yet again, the key to estate planning is the planning, but the Unitrust is a very useful (and greatly under-utilized) tool and this a good starting point for the discussion.