Lynn Brenner's Family Finance

Death Doen't Automatically Wipe Out Debts

Q: My late uncle was in a nursing home in New York State for about a year. They were applying for Medicaid, but he died before they finalized the Medicaid process. He left many bills, and a residence valued at about $40,000. He also left a bank account with about $30,000 in trust for me. Is that money mine, or will the nursing home or Medicaid come looking for it?

 

A: Medicaid isn’t one of your uncle’s creditors if the Medicaid application process was never completed. But everyone else he owed money to – including the nursing home -- definitely has a claim on his estate.

Your uncle's estate must pay his outstanding bills before any assets are distributed to his heirs. 

To be sure, New York law does make some assets off limits to most creditors: They can’t touch the proceeds of life insurance policies, or collect from annuities or retirement accounts that have designated beneficiaries. If your uncle had named you as his IRA beneficiary, you could be confident of inheriting that account. 

But a bank ‘in trust for’ account isn’t on the list of protected assets. Your uncle’s creditors have first dibs on it. Depending on how much he owed that nursing home, there may be nothing left for you.

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

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

Tapping an Inherited IRA: Don't Shortchange Yourself!

Q: I have an Inherited IRA. I've chosen to take distributions from the account over five years. I'm in the second year now. I have two questions. 

First, is the distribution amount determined by the IRA's value in the first year, or does the amount change over the five years due to losses and gains in the account?

Second, I'd like to skip this year's distribution to avoid being pushed into a higher tax bracket. Is it possible to skip this year and divide the remaining distributions among the three years I have left? --PS via email

 

A: You have more freedom than you realize. 

First, it sounds as if you still have the option to take minimum annual distributions based on your life expectancy. If so, you should grab it. It's a better deal than having to empty the account within five years. 

Second, even if you stick with the five-year rule, it doesn't require annual distributions. It just says you must empty the Inherited IRA by the end of Year Five. If you want, you can skip years one through four and withdraw the entire balance at the end of year five.

"IRA custodians don't usually ask for an affirmative election of the five-year rule," says Barry C. Picker, a Brooklyn NY CPA and financial planner. In other words, you probably aren't committed to emptying the account in five years and still could switch to withdrawals based on your life expectancy.

Before explaining why that's preferable, let's quickly recap the rules. What you can and can't do with an Inherited IRA depends partly on whether you were married to the original owner. We'll keep it simple and say you inherited an IRA from your uncle Joe. 

--If you're the named IRA beneficiary, and Joe was under 70 1/2 when he died, you can a) take yearly distributions over your lifetime; or b) empty the IRA within five years. It's hard to imagine a situation in which b) would be a better choice, says Picker.

--If you're the named IRA beneficiary and Joe was over 70 1/2, he was already taking required distributions from his IRA when he died. In that case, you can a) take annual distributions based on your life expectancy; or b) take annual distributions based on Joe's remaining life expectancy had he lived. If Joe was 76, for example, he had a 22 year life expectancy. "But in this situation, you don't have the five-year option," says Picker.

--If you weren't the named IRA beneficiary, you have fewer choices. For example, perhaps Joe made you his heir in his will, but neglected to fill out an IRA beneficiary form. In that case, says Picker, the IRA beneficiary is actually Joe's estate. You inherited the estate, so you get the IRA -- but you don't get a beneficiary's option to stretch distributions over your own life expectancy. If Joe was over 70 1/2 when he died, you can take annual distributions based on his remaining life expectancy. But if Joe was younger, you must empty the IRA within five years. 

Okay -- so let's assume Joe died in 2010. You inherited his $100,000 IRA as the named beneficiary, which gives you several distribution choices. You picked the five-year option. You took a $20,000 distribution in 2010, assuming that it was required. But actually, the five-year rule just says you must empty the IRA by December 31, 2015 -- the end of the year containing the fifth anniversary of Joe's death.

By contrast, with annual distributions based on your life expectancy, you must take the first distribution by December 31 of the year after Joe's death -- i.e. December 31, 2011.

If you're 48 years old, you have a 36 year life expectancy. Each annual distribution is based on the IRA's value at the end of the prior year. If there was $80,000 in the IRA on Dec. 31 2010, your 2011 required distribution is $80,000 divided by 36 -- $2,222.

Lifetime distributions are a better choice because they minimize the amount you must take out every year. There's less of a tax bite, and less chance that a distribution will push you into a higher bracket. And as I explained in this earlier post, your inheritance has a chance to become much bigger because the IRA balance can grow tax-deferred basis much longer. And there's no downside: You're always free to take a bigger withdrawal if you need the money.

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.