Lynn Brenner's Family Finance

My Daughter's On The Deed To My Condo. How Will It Be Taxed When She Inherits It?

Q: Is it foolish of me to have my daughter listed as co-owner of my condo? She and I are both on the deed. I've read that her name should be taken off so that the condo will be an inheritance, for tax purposes, when I pass away. -- PE, via email

A: It sounds as if you're the only one who lives in the condo even though your daughter is also on the deed. If that's the case, she'll get the full benefit of inheritance tax treatment at your death.

The tax law applies differently to different situations. Here are four scenarios:

In Scenario One, your daughter isn't on the deed. In that case, she inherits the condo at its market value at the time of your death -- or, in tax jargon, she gets a 'stepped-up' cost basis. When you sell a condo, your taxable profit is the sale price minus your cost basis. So if the condo is worth $250,000 when your daughter inherits it, her cost basis -- 'stepped-up' to its market value -- is also $250,000. If she sells the condo for $250,000, her taxable profit is... zero!

In Scenario Two, you and your daughter are both on the deed and both live in the condo. At your death, she inherits your half, on which she gets a 'stepped-up' cost basis. The condo's worth $250,000, so she gets a $125,000 cost basis on half its value. But her cost basis on the half she already owns is half of the condo's original cost. If you originally bought it for $100,000, her cost basis on her half is $50,000. Her total cost basis is therefore $175,000 --$125,000 (on your half) plus $50,000 (on her half). If she sells the condo for $250,000, her taxable profit will be $75,000.

In Scenario Three, you give the condo to your daughter for Christmas. (You'll move into a new condo down the street.) Your daughter has received the condo as a gift during your lifetime, and therefore she also gets your original cost basis. When she sells the condo for $250,000, her cost basis is the $100,000 you originally paid for it. Her taxable profit: $150,000.

Clear so far? Then let's move on to your actual situation, which we'll call Scenario Four.

In Scenario Four, your daughter is on the deed with you but she doesn't live in the condo and won't inherit it until your death. This is a common arrangement between parents and adult children. The legal jargon for Scenario Four is that you have retained a 'life estate' in the condo. Translation: It's understood between you that you'll spend the rest of your life there, and she'll get it after you die.

There's nothing in writing, you say? It doesn't matter. The IRS takes the position that when this arrangement is between a parent and a child, the mere fact that the parent continues to live in the condo implies the existence of a retained life estate, even if there's nothing in writing.

The IRS gives Scenario Four the same tax treatment as Scenario One: At your death, your daughter will inherit the condo at its full 'stepped-up' market value. (UPDATE: Since I wrote this post in November 2009, Congress has let the federal estate tax expire. The result: if you who inherit under Scenario Four from someone who died after January 1, 2010, you won't get a step-up to market value. However, that caveat is temporary. As soon as Congress passes a new federal estate tax law -- which it is expected to do this year -- people who inherit property in which the decedent retained a life estate will once again inherit it at its market value.)

Whenever I write about this, I get letters of protest from readers saying that their tax accountant insists Scenario Four is a lifetime transfer and therefore gets the same tax treatment as Scenario Three.

So here are the pertinent citations from the Internal Revenue Code:

Section 2036 of the Internal Revenue Code says that when you retain a life estate in your house, 100% of its value is included in your taxable estate when you die. And Section 1014 of the Internal Revenue Code says that your heirs get a 'stepped-up' cost basis on everything that is included in your taxable estate when you die, with a few exceptions ... which do not include a retained life estate. Therefore, your heirs get the step-up on a house (or condo) in which you had a retained life estate.

Indeed, the Scenario Four tax treatment has historically applied even if you move out of the condo before you die. For example, in a 1969 case, `Linderme Estate vs IRS', the court ruled that a retained life estate was still valid despite the fact that the decedent had vacated the property 19 months before he died to enter a nursing home.

Please send your questions to [email protected].  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved

Why Does My Son Want Me to Consult an Elder Lawyer? I Already Have a Will.

Q: My husband recently died. I want to be certain that my three children will inherit my house, which my husband built himself. My will leaves them everything I own. One of my sons recommends that I see a lawyer specializing in elder law. I am 78 years old and in good health. My monthly income from my pension and Social Security is about $1,800. A one hour elder law consultation will cost me $425, and I'm required to divulge my bank accounts, fixed annuity, IRA, and whatever other assets I have. But friends have told me elder lawyers would be adding charges that could go into the thousands. Won't my will suffice? Must I get involved with elder law? -- VT via email

A: The consultation won't commit you to paying anything except the $425 consultation fee.  The lawyer will tell you what additional services would cost. It's up to you whether or not you want to proceed.

Anything you tell him is confidential, privileged information. You don't have to take your kids along to this meeting; but if you do, you can ask them to leave the room before discussing your finances.  No experienced elder lawyer will expect you to divulge your assets in front of your children!

Is your will enough? Maybe, maybe not. Here's the potential flaw in your current estate plan:

Your will leaves the house to your children. But your son may be concerned that if you ever need nursing home care, the house might have to be sold to pay for that care. He probably hopes that an elder lawyer -- an attorney who specializes in estate planning, wills, trusts, and arrangements for long-term care -- can suggest a way to make sure that, if necessary, Medicaid will pay for your care without requiring the sale of the house.

Or he may hope the lawyer will assure him that you have sufficient savings to cover the cost of your care without having to sell the house.

There's nothing to panic about. You're in good health, and you may never need nursing home care. And if you ever do, you might decide that you prefer to sell the house to pay for your care rather than depend on Medicaid.

But all you need to decide at the moment is whether it's worth $425 to learn if there's a way to be certain your kids inherit the house your husband built no matter what happens. Whether or not you act on what you learn is another matter. And that, too, is entirely your decision.

Please send your questions to [email protected].  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved

NEED TO CASH CD: escape early withdrawal penalty?

Q: My condo burned to the ground last summer. I received money in early October, and put it in a 6 month Certificate of Deposit at Citibank. I was originally told repairs to the condo would take a year to complete. But as things stand, they'll be finished in April. The problem is the CD matures in April, and I need some of that money now. Is there a hardship clause that would allow me to take a portion of that $130,000 CD and give the contractor the money he needs to complete the project? -- MA, via email 

A: You're really at Citibank's mercy in this situation.  

Federal law says when you invade a CD within the first six days after your deposit, you must be charged a minimum penalty of at least seven days simple interest on the amount you withdraw. But other than that, banks are free to set their own penalties and there's no maximum limit. 

According to Bankrate.com, a personal finance website that tracks bank fees and interest rates nationwide, it's not unusual to forfeit three months of interest when you cash a two-month to 12-month CD before it matures -- and you could lose up to six months of interest when you cash out a 13 month to 36 month CD. 

In a worst-case scenario, you could lose some of your principal. For example, if the early withdrawal penalty is six months interest and you cash out an 18-month CD after four months, you owe the bank more interest than you've earned! 

Of course, banks do sometimes waive the penalty. If you die before your CD matures, for example, most banks won't charge your estate the early withdrawal fee.   

And they usually waive the early withdrawal penalty if your CD is also an Individual Retirement Account and you're over 70 and a half and must take a minimum annual withdrawal. 

You have nothing to lose by explaining your situation and asking Citibank to waive the penalty. You may find that the bank manager understands that customer goodwill should be a priority for a bank that owes its survival to the taxpayers.  

If not, here's some cold comfort: The early withdrawal penalties you pay on CDs are tax deductible.

HOUSING EXPENSES: mom doesn't want to pay her share

Q: My mom has a `retained life estate’ in her home, with me and my sister on the deed as owners. My mom does not feel she should be paying all the expenses on `our home', which include the taxes, insurance and repair and maintenance costs. Who exactly is financially responsible for all these expenses in this situation?  

Also, when my mom dies, I want the house to be sold, and my sister won't agree to that. Does this become a lengthy court battle? -- DB via email 

A: No need for that. You and your sister should be able to resolve the issue amicably down the road. Meantime, you have a more pressing concern: explaining to your mother that she is responsible for all the expenses on her house. 

Let's start by clarifying your situation for other readers. Your mother transferred the house to you and your sister, but she kept lifetime occupancy rights for herself. (In legal jargon, this is called a transfer with retained life estate.) All three of you are on the deed. Your mother owns a present interest in the house. You and your sister own a future -- or `remainder' -- interest.  

The main reason for a parent to do such a transfer is to make sure that her children will inherit her house even if she eventually applies for Medicaid to cover the cost of nursing home care.  

Under current New York law, if your mother is the sole owner of the house, Medicaid could put a lien on it, and sell it after her death to recoup the benefits paid for her care. That can't happen if you're on the deed too.  

For the parent, one attraction of this type of transfer is that it preserves her control over her house.  

Your mother doesn't have to let you or your sister move in with her, for example, or take your advice about redecorating the living room. If she wishes, she can rent the house to a tenant and keep all the rental income.  

The only thing she can't do is reclaim the future interest she gave you.  

She also retains all her financial obligations with regard to the house. "The person who owns the life estate is responsible for maintaining the property and paying the taxes," says Stephen J. Silverberg, an East Meadow New York estate lawyer.  

Indeed, he adds, if your mother doesn't keep the house in reasonable repair, you and your sister could sue her in Surrogate's court -- and if you get a judgment, foreclose on her.  

As for the future, if you and your sister don’t agree about selling the house, she can buy out your interest after your mother's death. "One 50% owner should have no trouble getting a 50% mortgage to buy out the other," says Silverberg.

Please send your questions to [email protected].  I'm sorry I can't respond personally to every email. Questions are only addressed online.(c) Lynn Brenner, All Rights Reserved