What happens when a well-meaning person decides to create a will, after reading information from various sources on the internet? As described in the Glen Rose Reporter’s article “Do-it-yourself estate plan goes awry,” there’s no end to the potential problems.
The woman started her plan by deeding her home to her three children, retaining a life estate for herself.
By doing so, she has eliminated the possibility of either selling the house or taking out a reverse mortgage on the home, if she ever needs to tap its equity.
By deeding the house, the transfer has caused a taxable transaction. Therefore, she needs to file a gift tax return because of it. At the same time, her life estate diminishes the value of the gift, and her estate is not large enough to require her to actually pay any tax.
She was puzzled to learn this, since there wasn’t any tax when her husband died and left his share of the house to her. That’s because the transfer of community property between spouses is not a taxable event.
However, that wasn’t the only tax issue to consider. When the house passed to her from her husband, she got a stepped-up basis, meaning that since the house had appreciated in value since she bought it, she only had to pay taxes on the difference in the increased value at the time of her husband’s death and what she sold the property for.
By transferring the house to the children, they don’t get a stepped-up basis. This doesn’t apply to a gift made during one’s lifetime. When the children get ready to sell the home, the basis will be the value that was established at the time of her husband’s death, even if the property increased in value by the time of the mother’s death. The children will have to pay tax on the difference between that value, which is likely to be quite lower, and the sale price of the house.
There are many overlapping issues that go into creating an estate plan. The average person who doesn’t handle estate planning on a regular basis (and yes, that even includes an attorney who does not handle estate planning on a regular basis), doesn’t know how one fact can impact another.
Sitting down with an estate planning attorney, who understands the tax issues surrounding estate planning, gifting, real estate, and inheritances, will protect the value of the assets being passed to the next generation and protect the family. It’s money well spent.
Reference: Glen Rose Reporter (September 17, 2019) “Do-it-yourself estate plan goes awry”