Lynn Brenner's Family Finance

What Tax Do We Owe on Inherited House?

Q: My mom had a house with a life estate. My three brothers and I are on the deed.

My mom passed away on May 4th 2012. Is it true that we inherit her house at its market value, and the sale proceeds when we sell it will be tax-free for us? And is it also correct that there will be no federal tax on my mom's estate unless it's worth more than $2 million, and no New York state tax unless it's worth more than $1 million? What about capital gains tax? -- BS via email

 

A: You're asking questions about two entirely different categories of tax. Estate taxes are those levied on inherited assets. Capital gains taxes are an income tax levied on your profit when you sell an asset for more than you paid for it.

Let's start with the simple stuff. In this case, it's estate taxes.

In 2012, federal estate taxes are levied only on estates worth more than $5 million, and New York State's estate tax applies only on estates worth more than $1 million. So if your mother's estate was worth $5.5 million, $500,000 of it would be subject to federal tax and $4.5 million of it would be subject to New York tax.

Clear so far? Then let's talk about capital gains.

The basic tax rule is that when you inherit a house, you receive it at its market value, which means when you sell it you're taxed only on the sale proceeds above that market value. But if you receive a house as a gift during its owner's lifetime, you receive it at its original cost -- i.e., what the original owner paid for it. That leaves you with a much higher tax bill when you sell the house.

Sometimes people assume that in a situation like yours, the second rule applies. That's not so!

Your mother gave the house to you and your siblings during her lifetime, but she retained a life estate -- i.e., the right to live there until she died.

If she had given you the house outright, you would be taxed when you sell it exactly as she would have been taxed: you'd owe a capital gains tax on the difference between the sale price and her original cost plus any capital improvements she made. If you sold the house for $1 million, for example, and her original cost plus improvements was $60,000, you would owe tax on $940,000.

But thanks to her retained life estate, you inherited the house at its market value at the time of her death. As a result, when you sell it you'll owe taxes only on the difference between the sale price and that market value. If the house was worth $1 million when she died and you sell it for $1.2 million, for example, you'll owe tax on $200,000.

Every time I write about this, I get at least one email challenging me, so here are the citations that explain why you inherited the house at its market value:

Section 2036 of the Internal Revenue Code says that when you retain a life estate in a house, the total value of the house is included in your estate when you die. Ergo, your mother's house was included in her taxable estate. (This is true whether or not the estate actually incurred estate taxes.)

Section 1014 of the Internal Revenue Code says that your heirs receive what is included in your estate -- with a few specific exceptions that don't include life estates -- at its 'stepped-up' market value.

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

 

How Can I See My Late Step-Mom's Bank Info?

Q: My stepmother just passed. I'm in Suffolk County, New York. Who do I go to to see all her checking and savings account transactions from 2005 through 2012? --VY via email

 

A: Don't get your hopes up!

Unlike your stepmother's will, her bank transactions aren't public information.

Her executor -- the person she named to carry out the instructions in her will --has access to all your stepmother's financial records.

If you are one of her heirs or one of her creditors, and you have a legitimate reason for requesting specific information -- e.g., did your stepmother ever reimburse your late husband for those Long Island Power Authority bills he paid on her behalf sometime in 2002 or 2003? -- her executor is the person who can find it for you.

But I doubt that a good executor will let you search through seven years worth of her bank transactions merely to satisfy curiosity about what she did with her money. Would you want your own executor to let your stepchild do that?

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

Tax Tips for the Sandwich Generation

You know who you are. You're working fulltime, extending a financial helping hand (and maybe a roof) to your adult kids, and moonlighting around the clock as the co-manager of your parents' multiple health care issues.

In other words, you're an aging baby boomer - a member of the generation right-wing pundits routinely excoriate as lazy and self-indulgent compared with its hard-working predecessors. Uh-hunh.

(In case you haven't guessed, so am I.)

The tax code doesn't provide much relief for the sandwich generation, but many of us don't take advantage of the small breaks that are available. You may find some useful pointers in an article I recently wrote for Reuters.

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

 

Can My Husband Get My 401(k) Plan?

Q: My husband wants my 401(k) now, but I don't want to get distributions until I have to. Will he win if he goes through the court system? What is his right to my 401(k), which I opened before I married him? Right now, my daughter is my beneficiary. We have no pre-nuptial or post-nuptial agreement. --MT

 

A: Stop worrying. Your husband has no case to take through the court system. As long as you're alive, he has no legal claim to your 401(k) account. 

In fact, even if you want to take a 401(k) distribution yourself, you can't  do it while you're working for the company that sponsors the plan, unless you qualify for a special hardship withdrawal.

But your husband is legally entitled to be your 401(k) beneficiary unless he has waived that entitlement in a post-nuptial agreement. (Nobody can waive it in a pre-nuptial agreement because it's a right that doesn't exist until after you're married.) In fact, if you didn't give your 401(k) plan administrator a written waiver signed by your husband, the plan shouldn't have let you list your daughter as your beneficiary.

So what are your options if you want to make sure your husband doesn't inherit your 401(k) plan?

You have three choices:

1. You can persuade him to sign a waiver. 

2. As soon as you leave this job, you can transfer your 401(k) account into an Individual Retirement Account. (See my earlier posts on how to do a trustee-to-trustree transfer to avoid taxes.) IRAs aren't governed by the federal law that establishes the rules for 401(k)s. You can name your daughter or anyone else you choose as your IRA beneficiary. 

3. You can divorce your husband.  However, in a divorce he may get part of your 401(k) account even though you opened it before you married him. The reason: In most states, an account you have contributed to during your marriage is considered a marital asset. That makes it subject to division in a divorce. How big a share your husband might get depends on many variables, including how long you've been married and what other marital assets you own.  

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