Attorney H. Mark Bobotek can tell more horror stories than H. P. Lovecraft -- when it comes to estate planning, that is.
Take one Frederick County couple he's advising. The wife's mother put her house in the wife's name, thinking she'd be
better assured of Medicaid benefits. Later, the couple bought a restaurant in Ocean City. It failed and they wound up owing $50,000.
"Guess where the money comes from? The mother's house," Mr. Bobotek said. "But Mom still lives in it. Mom will be evicted to pay the creditors. Everyone says it won't happen, but all they did was make a bad business decision."
That's just one of many traps of improper or hasty estate planning for the passage of real property. Planners warn that without proper, timely advice from financial planners, CPAs and lawyers, a will, living trust, deed or other method of passing on property can become a nightmare for the heirs.
Computer wills, though increasingly popular, can be equally dangerous.
"They're not people. They're not talking about a situation and may miss something," said University of Baltimore law professor Wendy Gerzog. "Customize it. You may spend $2,000 to $3,000, but those with larger estates will save a lot."
"Real estate isn't a no-brainer like gifting $10,000 a year," Mr. Bobotek said. "With real estate, there's always a balance of positives and negatives with any action. What works for one won't work for another."
In Maryland there are three basic types of ownership of real property, and each form can affect the taxes paid by the estate. Depending on the type of ownership, a will, trust or the law usually controls the property's disposition upon the owner's death.
"Tenancy by the entirety" is the first form, and the way most married couples own their homes. Under T by E, neither partner can sell or transfer the home without the other's consent, according to Jeffrey Gonya, attorney with the law firm of Venable, Baejter & Howard.
When one dies, the property passes by right of survivorship to the surviving spouse. No will is involved when the first spouse dies. The property passes to the surviving spouse under the law and is not considered a probated asset. Thus, even if a husband wills the home to his son, the wife inherits it, if she's alive at his death and they've owned the home T by E.
A related form of ownership is "Joint Tenants with Right of Survivorship." Many unmarried people take this option. It is similar to T by E, and very commonly done with bank or stock accounts; not so common with real estate.
The third way is totally different from the first two and called "Tenants in Common."
"It's like owning a share of stock, in that you own a separate share of the real estate," Mr. Gonya said.
Often under this arrangement, business partners buy real estate for, perhaps, 50 percent each. They can do what they will with the property. This kind of ownership passes down through a will, not the deed. Tenants in Common is common with siblings or unrelated investors.
A danger to this form of ownership is that outsiders can obtain shares in the property's ownership if one of the co-owners gets into financial trouble and has to relinquish the property to a creditor, for example. The original owners can wind up with a partner they don't want, and that part of the property could be sold again and again. If it's a major portion, that new owner could press his or her voting rights and severely complicate the property's financial future.
"And should an adult child die, it doesn't necessarily go back to the parent," Ms. Gerzog added.
Instead, the share of ownership could pass to the adult child's spouse, or child -- sparking further control issues.
Mr. Gonya remembers a case where the adult children were tenants in common. When the father was 75 and wanted to raise money to go to a nursing home through the sale of his home, he had a rude awakening. One son had died. The son's wife (whom the father disliked) was entitled to a share of the sale's proceeds. She refused to give the money back to her father-in-law.
Of course, you can also sell property outright. If you sell your home and are over 55, you can take advantage of a once-in-a-lifetime $125,000 exclusion on capital gains (for a husband and wife together). Of course, selling it doesn't reduce your estate per se, because the real estate has simply been converted to cash. Or, you might sell the home to your children at fair market value, specifying that the balance of the mortgage is to be forgiven at your death. The estate then would only include what hadn't been paid off.
Death triggers a number of tax scenarios, depending on what kind of estate planning was done.
Federal and state estate tax (usually lumped together for computing purposes) can take serious chunks of the estate, if the value of the gross estate tops $600,000. (That limit is expected to rise to $750,000 by 2001).
At first glance, those figures make many think estate planning is only for the rich. But financial advisers say that the value of the home, cars and life insurance policies reaches the $600,000 mark faster than many people anticipate.
Federal estate taxes of 37 percent to 55 percent apply to estates over $600,000, depending upon how much they are over the limit. Suddenly, heirs can find themselves paying thousands of dollars in estate taxes if an estate is planned improperly.
Maryland inheritance tax applies to the first dollar of the estate and is quite complex, attorneys say. There's a 1 percent tax on transfers to immediate family members, such as your spouse, children or grandchildren. Then there's a 10 percent transfer tax to collateral beneficiaries, such as a friend you name as a beneficiary.
One exception is on real estate's transfer to the surviving spouse. If you leave your home to the spouse, there's no inheritance tax if you own T by E.
There are many ways around tax laws, but you have to make sure you're not robbing Peter to pay Paul. One real break is that you can leave an unlimited amount to your spouse, tax free -- and up to $600,000 to those other than your spouse, tax free. Financial analysts add that a married couple has a total of $1.2 million ($600,000 X 2) it can pass down, tax-free. Often, however, a couple doesn't plan well enough. If a husband dies and leaves everything (through joint ownership) to his wife, his $600,000 credit is gone forever. Thus, if the wife's estate, considering the value of the home and life insurance policies, rises above her own $600,000 credit, the estate must fork out taxes before any heirs can touch it.
"If you title all your assets in joint name with your spouse, he or she gets everything when you die. It's simple and you avoid probate, but it may be bad tax planning," Mr. Gonya said. "To the extent that your combined assets exceed $600,000, unnecessary estate taxes will be paid."
Dividing assets is a very popular way to use both credits. After dividing asset ownership (of, for example, a $1.2 million combined estate), the first spouse to die could leave his or her half to the children outright or in a tax-exempt trust for the benefit of the wife and children. The children don't lose any of their estate to taxes, and the wife still has her $600,000 free and clear. When she dies, her assets, perhaps $400,000 (after her own $200,000 for living expenses), pass to her heirs without estate tax. Both $600,000 credits are used, saving thousands.
The probate process
Probate is the process whereby your will is proved valid in court. An executor has the power to transfer your assets to the beneficiaries. You need letters of administration to authorize an executor to transfer the title -- a will isn't good enough. (If you and your husband jointly own property, the surviving spouse only needs a death certificate to resell it).
Some people prefer probate because it is a way of making sure that the will is legal and above-board, and it's often cheaper than transferring assets to a trust. Probate fees range to about $1,000. Probate can also limit the time in which creditors can make claims on the estate.
Others believe probate is an invasion of privacy (the will is made public) and time-consuming (15 months on average). Expenses usually add up to 4 percent to 6 percent of the estate's gross value, Mr. Bobotek said. However, the probate process has become popular with farmland because it limits liability after the decedent's death. If farmland passes through probate, for example, creditors can bring a claim against it only until probate closes.
One popular way to avoid probate is the living, or revocable, trust. These are trust funds you set up and can change or revoke at any time. They also don't have to go through probate, thus stay private. Such trusts generally don't reduce the estate or estate tax, however, and can be costly and complicated to establish.
With such a trust, the property continues in your name and you won't have to worry about unwelcome owners or creditors taking the property. Also, you can change your mind, unlike with gifting.
Some homeowners want to put their children's names on the deed or simply gift the home to them over the years, to avoid probate. If you gift it or re-deed the home to your heirs before you die, however, they must pay capital gains tax on the appreciation if they sell the home.
If you don't re-deed, all the property appreciation you've racked up in your life is forgiven upon your death. Thus, if you bought your home for $30,000 in 1966 and it's worth $230,000 now, and you've lived there for those years, your estate wouldn't have to pay capital gains on $200,000.
Re-deeding can also cause creditor or ownership problems if a child goes into debt or pre-deceases the parent. Family squabbles can erupt if only one sibling is named on the deed.
"Things don't get to the other kids the way they should with homemade wills or joint ownership with only one child," Mr. Bobotek said.
Mr. Gonya recommends that, rather than giving direct interest in real estate to children, clients consider transferring the real estate to a family limited partnership and giving partnership interest to the children. This enables the parent, as general partner, to control the property.
Many homeowners fear that if they keep the home in their name it will be harder to qualify for Medicaid for nursing home care. Medicaid qualification wait-times can last three or more years, and many seniors view selling their home or re-deeding it as extra "insurance" to qualify, Mr. Bobotek said.
"They trade that for the certainty of capital gains tax," Mr. Bobotek said. "You don't realize the mistake when you make it -- but later on."
Farmland can be a different story when it comes to living trusts, said certified public accountant Lambert Boyce Jr., with the accounting firm of Clifton Gunderson Inc.
If you pass on your farm through a living trust, liability may continue to vex your heirs because it doesn't go through probate, he said. Many farms have underground gas or heating oil tanks, or other chemical problems that current owners may not even be aware of, but that can prompt lawsuits.
Another caveat is that farmland is valued for taxes at its "highest and best use." The government will only value that land as farmland if it is farmed.
But, if the heirs want to stop farming and convert the property to personal use, the government will revalue the land at the highest and best use and charge estate taxes and interest on what you didn't pay when you inherited the land, Mr. Boyce said.
That can cause major battles within the family, especially if siblings inherit a farm and disagree about how it should be used in the future.
How and when real estate is passed on from parents to children can have major tax consequences.
1. Inheritance of real estate: A house purchased for $30,000 in 1966 is now worht $230,000. The daughter inherits the house through a will and sells it for $230,000. Her capital gains tax is zero because the IRS lets her value the home at today's value. The home may have to go through probate.
2. Jointly owned real estate: The parents own the house jointly with the daughter who is on the deed. After both parents die, the daughter wants to sell the house for $230,000. The IRS says the basis for taxation is $30,000, the original price, times 50 percent, since she owns half the house. She sells the house and she must pay capital gains taxes on her half of the house($115,000) minus the $15,000 basis, which equals $100,000. With a capital gains tax rate of about 29 percent federal and 7 to 8 percent state, that's up to $35,000 in taxes.
3. The entore house is deeded to the daughter during the parents' lifetime to avoid probate. If she sells the home, the daughter would then pay capital gains taxes on $230,000 minus $30,000 (the original price), which is $200,000. She could pay up to $70,000 in taxes.