Estate Administration


Is it valid from one state to the next?  Let’s say you have had enough of those Michigan winters and one day you happen to see the headline – North Carolina is ranked #1 among places to retire.  A year later you’ve just arrived in your new NC home and you’ve ordered a pizza while you contemplate the tedious chore of unpacking.  Wait a minute….what about your Will and other estate planning documents?  Do they still work? Or better yet….I wonder what happened to those documents?  Of course that is the last thing on your mind, but somewhere on your “To Do” list you should include a review of your documents and how they work in your new state.

 First things first: Yes, an out-of-state Will should be valid in North Carolina as long as it was prepared and executed in accordance with the laws of the other state.  This is also true for other documents such as financial Power of Attorney and Health Care Power of Attorney.  The problem is that these out-of-state documents may be much more difficult to use here in North Carolina and this may create headaches for your family.  Our courts, financial institutions and health care providers, will likely not be familiar with most out-of-state forms and this disconnect leads to delay and added administrative requirements.

 North Carolina has very specific requirements for language which must be included in a Will for the document to be probated in the normal course.  Without this magic language, it can be a real pain to probate a Will; you may have to locate witnesses from years ago in another state, or you may have to pay for a substantial security bond for an out-of-state Executor.  For this reason I regularly advise clients that, at a minimum, they should have their documents reviewed by a North Carolina attorney.  We often recommend that a client execute a new North Carolina Will to replace their existing document simply to ensure that the necessary language is included to avoid problems with probate.  We also regularly replace existing financial Powers of Attorney and Health Care Powers of Attorney with our North Carolina versions because they will be easier to use with our local institutions; since they are fairly standard forms they don’t require much time and expense to prepare.

 Some clients have a Living Trust as part of their estate plan which is designed to work in conjunction with the Will.  In many cases that Living Trust is designed to continue to function under the old state’s law regardless of where the client may live.  One benefit of a Living Trust is that it will not be subject to probate or review by the court at the client’s death.  In this case, we are not concerned with any special North Carolina language for these documents and we often don’t recommend any changes to a Living Trust simply because of the relocation to our state. 

 When people relocate to North Carolina, particularly for retirement, they regularly have other revisions to include in their documents which can be addressed at the same time their new North Carolina documents are prepared.  For example, if a client is moving to be near one of their children it is common to have that child serve as the primary fiduciary for the client (e.g. Executor or Health Care Agent) and this will often require an update in the documents.  There is also the ever-changing landscape of estate tax laws and this too will dictate changes in documents if they have not been revised recently. 

 If you or someone you know recently migrated to our fair state, be sure this chore is added to the list right along with changing your driver’s license and voter registration and finding a great Chinese food place. 

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Gifts of your real estate can be a bad idea for taxes. What?????? Many of you have probably heard that you should give real estate to your kids to help minimize estate taxes….yes that is still true….but that is only applicable if you have a large estate that will be subject to estate tax.  For most people estate tax is not a real concern.   Thanks to Congress and its ability to get only politics done….we don’t know who is subject to estate tax at the moment. We’ll know that answer at least by the end of 2010 but for now let’s just assume that if you have less than $1,000,000 then you have no estate tax concerns. 

 So if you have no estate tax concerns, a gift of your real estate is not saving your family estate taxes; you are wasting your time and money.  Of course your kids may not feel that way…who doesn’t enjoy ownership in a beach house or mountain cottage. However they may be interested to learn that the gifts can be bad for their income taxes if they ever plan to sell the property.

If you make a gift of your real estate during life instead of passing the property at death, your kids will use the same cost basis you have in the property to determine their income tax if they ever sell the property.  Basically your kids step into your shoes with regard to the built in capital gain in the property.  Admittedly, with the recent real estate turmoil, appreciated property ain’t what it used to be, but there are still plenty of old family farms out there that have vast appreciation built in which has not yet been taxed.  If that property is passed at death, the cost basis is increased to the fair market value of the property and the capital gain is wiped out, at least to the extent the gain is below $1,300,000.  On the other hand, if you transfer the property through gift during life, you loose the benefit of this basis adjustment and your kids will have higher income taxes if they ever sell the property.  This rule is true for all kinds of property (stock, art, etc), but real estate is the most common application.

As with any area of tax law there are some exceptions and special facts which may dictate a different plan of action.  For example, if the real estate is a principal residence occupied by the child, or if the property is expected to appreciate substantially, or if the family is exploring planning to help with medicaid qualification, then these factors may justify a gift even in the face of the potential income tax detriments.  Also, the basis adjustment rules are in flux at the moment and are likely to change further as part of the resolution of the estate tax, whenever that happens.

If you are considering a gift of real estate, make sure you consult your tax advisor first to determine whether you are gaining or loosing any tax benefits.

 

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Many of you have heard about the benefits of owning real estate in a limited liability company (LLC) to provide protection from liability arising out of your ownership of the real property.  See my June 2009 newsletter for further discussion.  This is pretty standard advice that you will hear from most advisors, including me.  However there is one area where the decision to re-title real estate into an LLC is not so clear: real estate owned by husband and wife, particularly where one of them is in an occupation that is exposed to professional liability.

In North Carolina real estate owned by husband and wife as tenants by the entireties is protected from each spouse’s individual creditors.  This means that if one spouse has a judgment entered against them individually, the judgment creditor cannot enforce the judgment against any real estate as long as the real estate is owned by husband and wife as tenants by the entireties.  This can be important, for example, where one spouse is a doctor and subject to potential malpractice liability.        

If real estate is re-titled into an LLC as per the typical advice, then the husband and wife will lose this special protection which only applies to real property; their ownership interest in the LLC will be subject to their individual creditors.  Some of you may be thinking….but doesn’t owning an LLC interest provide some protection against collection from creditors?  Yes it does…but not nearly the protection afforded by the special tenancy by the entireties rule.  Now I am not saying that a husband and wife should never use an LLC for real estate; many of my married clients do.  My point is simply that there are some circumstances where re-titling real estate into an LLC may not be the best choice.  You’ll need to consider the decision on a case-by-case basis.

A few imporant qualifications to note….

1.  This special rule only applies to real estate owned by husband and wife as tenants by the entireties; that is the default type of joint ownership for a husband and wife in NC, but the real estate can also be titled as “tenants in common” which does not afford the special protection.  You need to check your deed to be sure.  Also, if one spouse owned the property before marriage then it is not in tenants by the entireties unless it is re-titled after the marriage.

2.  I am only speaking about NC law.  If you have property in another state, the discussion above is irrelevent for that property, though there may be similar laws which apply in the other state.

3.  The IRS takes the position that it is not bound by this special exception, so it may enforce an individual claim against any property owned by husband and wife.

4.  The protection only applies to individual claims; if both husband and wife are liable for a claim the protection is not applicable.

If you are married and considering an LLC for real estate, make sure you ask about the tenancy by the entireties rule.

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Do you have real estate owned in your corporation?  Watch out for a tax surprise!

Many of you have heard from your advisors (including yours truly) that if you own real estate either for your business or for investment then you need to protect yourself from liability by having the property titled in some form of corporate entity; see my June newsletter.  However, it is very important that you choose the right type of entity to own your real estate.  As a general rule, you should not use a corporation.  Why?  Corporate tax law is not friendly to the real estate owner.

I will spare you a lengthy discourse on the ins and outs of corporate tax laws, although I assure you that it’s fascinating!  The short answer is that real estate owned inside of a corporation generates an unexpected tax liability if you ever wish to move that property out of the corporation.  Let’s say that you acquire a couple of rental properties with a friend and you set up a corporation as the owner, but some years later you and your friend decide to part ways and split up the properties.  This would typically involve dissolving the corporation and transferring property out to each owner.  The problem is that the tax law treats that transfer of property as a “deemed sale.”  If the property has appreciated then that deemed sale triggers a capital gains tax for the corporation.  It is irrelevant that you haven’t actually sold the property or that no cash has changed hands.

For this reason, you should avoid using a corporation to own real estate in most cases.  Keep in mind that I am talking about real estate that you buy and hold (e.g. a location for your operating business, rental or investment property).  If, on the other hand, you are in the business of buying and selling real estate on a short term basis, then a corporation may work perfectly well for your needs, since you will recognize a tax liability anyway when you sell property; there is not the same potential for a deemed sale surprise.

Enter stage left….the limited liability company (LLC).  An LLC is typically taxed as a partnership, which operates under entirely different tax rules.  In particular, real estate can almost always be moved in and out of the name of an LLC without generating a tax liability.  Since the LLC still provides the same basic limited liability protection available in a corporation, the LLC has become the entity of choice for owning real estate.

What about an “S” corporation?  An “S” corporation is, in many ways, taxed like a partnership, however one important difference is that the deemed sale rule described above will still apply for an S corporation.  Although there may be special circumstances that help decrease this tax liability with an S corporation, the better option is to stay away from a corporation altogether.

If you are unfortunate enough to have a corporation that owns real estate already, then you may be stuck with this potential tax issue until you are ready to sell the property.  But please talk to your tax advisors before you take any action; you may have planning options to help minimize the tax liability.

Remember, tax time is no time for surprises.

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