The myriad options presented to homebuyers when titling real estate have significant tax, asset protection, and estate planning consequences. Failing to consider these issues often results in unanticipated taxes, liability, fees, and headaches. This article discusses a variety of potential pitfalls that should be considered when purchasing or re-titling property.

First Pitfall: Failure to plan for Probate

The way homebuyers title real estate determines whether a probate will occur. You might ask, what is Probate and why should I be concerned about it? When people talk about Probate, they are referring to the court-supervised administration of estates.  Under California Probate Code §§10800 and 10810, probate fees for the each of the attorney and personal representative are 4 percent on the first $100,000, 3 percent on the next $100,000, 2 percent on the next $800,000, and so on. These fees are calculated on the gross (not the net) value of the estate.

For instance, let's say that Jim, who is not married, dies owning one asset, a house worth $1,000,000 with a mortgage of $500,000. Jim's house is titled in his name alone. Jim's will leaves the house to his three children, one of which is named as personal representative. The probate fees here would be as follows: $23,000 to Jim's attorney (plus any "extraordinary fees") and $23,000 to the personal representative (if he/she decides to take a fee). The minimum fee for this probate is $23,000, however it could easily rise to $46,000 or more. As noted above, these fees are calculated without taking into account the $500,000 mortgage, because the fees are charged on the gross (not the net) value of the estate. As you can see, Jim's estate does not have enough liquid assets to cover the expense of the probate!

How can Jim avoid probate fees? First, he could establish a revocable trust and transfer the property to himself as trustee. In that case, the asset would not have to pass through a probate procedure, because it would be transferred directly by a successor trustee. However, Jim needs to make sure that his trust is fully "funded" at the time of his death. Otherwise, a probate might still be required. Often, trust documents appear to be valid on their face, but the underlying assets have not been funded to the trust. Jim should seek an attorney's counsel in order to ensure that his trust is funded and remains that way.

What if Jim never establishes a revocable trust?  Could he get by with joint tenancy? If Jim were married, he could avoid probate at the death of the first spouse by owning his real property as in joint tenancy with his spouse. Joint tenancy means that two (or more) people own property in equal shares. On the death of either person, the entire interest automatically passes to the remaining owner, and probate is avoided.  Of course, on the death of Jim's spouse, the real estate would still be subject to probate. In addition, titling property in joint tenancy without consideration of whether the property is separate or community may result in unintended tax consequences (see below). Also, Jim might benefit from some estate tax planning, which may be better facilitated when  planning with trusts. Ultimately, ownership of the property in a funded revocable trust while giving full consideration to the real estate's community property status and estate tax issues will give Jim the best protection.

 
Second Pitfall: Listing your Child on the Deed
 
What if Jim owns his property jointly with one of his children? The idea of listing a child on a deed as a joint tenant often appeals to parents. This approach appears to offer a simple, cheap way to transfer property on death, avoid probate, and perhaps even avoid taxes. However, adding a child to the title of your house could result in disastrous consequences, both during life and at death. At the end of the day, it is rarely advisable to take this "shortcut."

First, owning a home in joint tenancy exposes the parent to liability for the child's actions. For instance, the child's gambling habit or addiction may put the real estate at risk. Or, say that the child is involved in a car accident. In such case, the court could place a judgment lien on the child's interest in the property. This is true regardless of whether the parent's sole intent was to facilitate a transfer of real property at death.

Second, naming a child on the deed often frustrates a parent's overall estate planning objectives. A parent may want their children to live in a home as long as they are under age 18, or for the home to be sold and the proceeds distributed equally among multiple children. Alternatively, a parent might wish for one child to have the family home, but the other child to be compensated with liquid or business assets. A will or trust may provide exactly how property should be distributed, or empower a trustee with discretion to distribute such property. As parents often forget, however, a joint tenancy interest passes outside of the terms of one's will or trust. While a will may clearly provide for equal distribution, this makes no difference as far as the joint interest is concerned. As a result, one child may get an inheritance boost, while another may wind up with a smaller proportionate share of the estate.

Third, and perhaps most important, adding a child's name to a property can result in disastrous gift and estate tax consequences. If the child has not contributed an equal amount of money as the parent when purchasing a home, the parent could be liable for a gift tax in the year the home was purchased or transferred. Later, after the parent dies, the entire value of the home will be included in that parent's estate for estate tax purposes unless it can be established that the child contributed to the purchase. In view of both the gift and estate tax consequences of holding property with a child, it is rarely advisable to pursue this approach!

Third Pitfall: Failure to consider Basis Step up

The way in which homebuyers title property affects the basis "step-up." What does "step-up" in basis mean and how does it affect me? Generally speaking, when property is sold, capital gains are recognized on the difference between the basis (the purchase price) and the sales price. At death, however, the basis of an interest passing by will or trust to a surviving spouse "steps up" to the value as at the date of death. As a result, the sale of property after a full basis step-up often results in substantial capital gains tax savings.

However, married persons may only receive a partial basis "step-up," limited to one half of an appreciated property at the death of the first spouse to die, if the property is not held as community property. By contrast, both halves of an asset held as community property will receive a full step-up upon the surviving spouse's death. In general, therefore, community property is usually the best form of ownership when property has a low basis or will most likely appreciate in the future. An attorney can assist married couples in determining whether property is community or separate.

Before running to the title company, remember that numerous other factors, not all of which are discussed in this article, should also be considered. These factors include: whether the property has depreciated in value such that a partial step-down in basis would be desired; whether more advanced strategies such as bypass trusts would warrant titling property as tenancy in common; or whether the property will be held in a revocable trust. This does not even touch the family law issues involved, or some of the more nuanced asset protection rules. Because so many factors are involved when titling property, it is advisable for individuals in California to consult with an attorney about how property should be held, while keeping in mind the goals of (a) basis "step-up" for California and Federal income tax purposes; (b) probate avoidance for the entire transferred interest; (c) the marital deduction for estate tax purposes; (d) asset protection and (e) minimizing liability. 

 

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IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

General Disclosure: This article is intended to provide general information about business entity selection and should not be relied upon as a substitute for legal advice from a qualified attorney.

While it's not a pleasant subject, sometimes parents pass away while their children are still under the age of 18. What happens then? By law, children under the age of 18 who receive anything more than modest amounts of money from their deceased parents' estate cannot manage the property on their own.  Instead, the law provides for court-appointed guardianship proceedings in order to manage and supervise the child's estate. On the one hand, court supervision is better than allowing the money to just disappear in the hands of unscrupulous friends or relatives. On the other hand, the practical disadvantages of guardianship proceedings are numerous:
  

1. The guardianship terminates when the minor reaches age 18, leaving assets in the hands of a child who is most likely to be financially immature. The majority of parents would rather postpone giving full control over their property until a later date.
2. The requirements of court supervision and formal accountings add expense and inconvenience. In addition, because the appointed guardian will likely need the advice and representation of an attorney at court, these costs will be borne by the child's estate and reduce the total amount of the gift.
3. Court oversight, and laws requiring court approval for sales of certain types of assets, diminish the likelihood that the child's property will be managed effectively.

By the way, guardianship of the estate should be distinguished from guardianship of the person, which means the appointment of a guardian by the court to protect a child in the event of a parent's disappearance or death. Parents should also engage in some planning to ensure that their choice for guardian of the person will be named if this ever becomes an issue; however that is not the subject of this article.
 

Solutions for avoiding guardianship of the estate. There are three major techniques for avoiding the problems associated with transferring assets to minors: (I) Custodianships, (II) Testamentary trusts, and (III) Minors trusts.
 

(I) Custodianships
 

A custodianship is a legal arrangement in which parents can nominate an adult to manage property for the benefit of a child until the child reaches a specified age, up to 25 years old. A custodianship is actually a type of trust, the terms of which are provided by law under the California Uniform Transfers to Minors Act (CUTMA). Parents can draft their will or living trust in such a way as to establish a custodianship over property transferred to minors. This can include any type of property, including stocks, bonds, cash, and real estate. Final distribution of the property to the minor by the custodian can be delayed up to the child's 25^th birthday. Custodians are held to strict fiduciary standards under the CUTMA, and are required to prudently invest and mange property.

Custodianships can be very useful when transferring modest amounts of assets to a minor. The ability to delay distribution until age 25 offers significant advantages over a guardianship. Furthermore, a custodianship does not require the court oversight, expense, and inconvenience of a guardianship.

The primary disadvantage of a custodianship is the inflexibility involved: the only thing parents can control is the termination date and the identity of the custodian. Yet even that power is limited as the termination date cannot exceed age 25. Every other aspect of a custodianship is rigid and unchangeable, including the guidelines on investing, managing, and distributing the property. Unlike a testamentary trust or minors' trust, explained below, custodianships cannot be tailored to match the way parents would themselves handle assets on behalf of their children. Moreover, multiple fiduciaries cannot be chosen, neither can parents pool assets for multiple children in a single account. Finally, should a child pass away prior to the termination date, parents cannot specify an alternative beneficiary, such as a brother, sister, niece, or nephew.

(II) Testamentary Trusts
 

A testamentary trust is a legal entity that is created upon the death of an adult, which provides for a trustee to manage the assets of a child until a pre-determined age. Set up either by one's will or living trust, a testamentary trust has several advantages over both guardianship and custodianship.

1. A testamentary trust can postpone payment of an inheritance well beyond age 18, in some cases lasting for the lifetime of a child. The trust can provide for changed circumstances, such as educational, business, or travel requirements, and can even support a child in the event the child is adopted. In the case of guardianship, by contrast, funds are cut off (or at least limited) at adoption. Custodianships can last beyond adoption, but will terminate at age 25 at the very latest.
2. Unlike a guardianship, a testamentary trust generally need not be subject to court supervision. This reduces the cost, complexity, and difficulty associated with managing the child's estate. The same is true for a custodianship.
3. Unlike both guardianships and custodianships, parents can decide exactly what standard should govern how the trust assets are managed and invested. Furthermore, parents are given flexibility in how the trust will provide for their children. This ability to customize the trust enables the trustee to make financial decisions similar to the way a parent would if the parents were still living.
4.  Unlike both guardianships and custodianships, a testamentary trust can specify alternative beneficiaries if the child is no longer living by the termination date.
5. Unlike both guardianships and custodianships, a testamentary trust can be established as a "pot trust," meaning that assets can be pooled for the use of multiple children beneficiaries. A pot trust is particularly advantageous when the parents' estate is not large enough to justify a division into separate trusts for each child. Moreover, a pot trust can provide for greater expenses incurred by one child (such as a sickness or education) without wiping out that child's inheritance. On the other hand, testamentary trusts can also be divided into separate trusts for each child if the parents so choose or the circumstances warrant.
6. Finally, a testamentary trust can be optimized to decrease taxes and expenses. A guardianship has no such flexibility. In a custodianship, the fiduciary is only limited by the broad standards of the CUTMA.

(III) Minors' Trusts
 
 

Minors' trusts are in a breed of their own, as they are established during the child's life and involve long-term financial planning. A properly structured minors' trust, or "§2503(c) trust," allows parents and other individuals make multiple tax-free transfers to a trust over a period of years, and then delay the final distribution of the assets until a date (or circumstance) of their choosing. During the trust's lifetime, a trustee is chosen who manages and distributes the assets according to a pre-determined standard.

A minors' trust is particularly advantageous from a gift tax perspective. Under the tax laws, an individual can only transfer $13,000 per year (in 2010) to a child without filing a gift tax return. An outright transfer of assets over $13,000 to a child or into a custodial account, for instance, must be reported to the IRS. By transferring up to $13,000 (or $26,000 per married couple) into a minors' trust each year, the trust can accumulate significant value over time. With a few exceptions, income and principal can be paid to the child according to the parents' stated intentions. Furthermore, any accumulation in the trust will not subject the parents to gift or estate tax as long as the trust has been properly drafted and managed. In most other respects, minors' trusts have the same advantages as a testamentary trust.

At the same time, minors' trusts involve making irrevocable transfers of assets during one's lifetime. Once transferred, these assets cannot be taken back. Also, unless no other assets pass to children upon a parent's death, minors' trusts should be coordinated with other estate planning documents. Furthermore, some of the drafting and tax rules associated with minors trusts are quite complex, requiring the assistance of an attorney at the very least during the drafting and set up of the trust.
 

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http://www.johncmartinlaw.com/.

Revocable living trusts have become one of the most popular testamentary devices in California. There are numerous reasons why individuals choose to execute trusts, including the avoidance of probate fees, the increase in privacy, and the ability for trustees to manage assets during the lifetime of the settlor (the person who first executed the trust). While trusts do achieve these and other objectives, they do not eliminate the need for a trustee to properly administer the trust upon the death of the settlor. Once the settlor passes away, trustees are often in a quandary as to what their duties include. This is not a situation where one should be left in the dark. If trustees fail to observe their numerous responsibilities, this can open the door to a petition to be removed from their position, or worse-personal liability.
 

1.     Observation of Numerous Deadlines

First, successor trustees of living trusts need to be aware that there are numerous deadlines that need to be observed when administering the trust. In California, the decedent's will must be "lodged" with the local probate court within 30 days of the date of death. This is true even if the decedent had a revocable trust. Also, beneficiaries and heirs must be notified within 60 days. The notice must adhere to strict legal requirements, and any failure in this regard could give the beneficiaries an extended right to challenge the trust. Often, identifying and locating heirs and beneficiaries will be a challenge. In addition, an application for an employer ID, personal and fiduciary income tax return filings, and possibly estate tax filings must be made within strict time limitations. There are numerous other deadlines, so please consider this just a list to get you started.

2. Funding the Trust
 

Second, successor trustees may need to fund the trust, depending upon the existence of a "pourover will" executed by the decedent. In that case, if more than $100,000 of assets are left outside of the trust, and those assets would otherwise pass by probate, a limited probate procedure may be required to fund the trust. The successor trustee will usually need to establish a separate account for the trust with the tax ID number they acquired. They will also need to invest or preserve the assets in the trust according to the specifications of the trust. If the trust is silent, they will need to follow the rules under the Uniform Prudent Investor Act. Often, trustees work with investment professionals to help properly invest trust assets.
 

3.      Preparing for the Final Accounting
 

Third, trustees need to maintain detailed records of all money in and out of the trust to prepare for a final accounting to beneficiaries. Under the California Probate Code, a final accounting must be sent to beneficiaries upon termination of the trust. The trust may opt out of this requirement, but in some cases the trustee may be required, or decide to produce an accounting in any event. This is because the preparation and delivery of an accounting will trigger a time period after which a beneficiary will no longer be able to sue for allegedly improper trust management. The trustee can keep these records by hand, but can also use accounting software or a third party accountant.

Keep in mind that trustees have numerous other responsibilities which, if not followed will open the door to litigation. Also, the trust document must be interpreted to determine whether there are any deviations from the Probate Code's default rules. Following a period of grieving, it's a good idea to then consult with an attorney to determine your particular duties and responsibilities under law.
 

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http://www.johncmartinlaw.com/.