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Funding Marital Gift and Credit Shelter Trusts

December 4, 2022 by David Moseman CPA

house estate plan and wedding rings

Baby boomers are inheriting their parents’ wealth, and their children are receiving funds transferred through a variety of trusts established under their parents’ estates. You may find yourself responsible for managing the wealth transfer process.

In the past, banks and trust companies were tasked with dealing with estates, but these days, individuals are taking on the jobs of executors and trustees. If you lack experience in administering estates and trusts properly, you may turn to the attorney who prepared the will or trust. But some lawyers refuse. They point to the potential conflict of interest and ethical problems swirling around questions of whom they represent — the fiduciary, the estate or the surviving spouse.

Estate administration involves complex questions about accounting and taxes, so if you have no background in those fields, you’ll need an adviser. While the knee-jerk reaction always has been to seek out an attorney to administer an estate, you may join an increasing number of folks who are turning to accountants. They are, after all, the best people to administer credit shelter trusts, an increasingly popular tool in estate planning.

One of the more popular credit shelter trusts is the marital gift trust, which preserves estate tax exemptions to be used later by trust beneficiaries. The will bequeaths to the trust an amount up to the value of the estate tax exemption. The remainder of the estate is then passed directly to the remaining spouse tax-free using the unlimited marital estate tax deduction. This divides an estate in a way that reduces the overall amount of estate tax paid.

In order for the credit shelter and marital trusts to be used effectively, married couples should examine how their individual assets are titled and whether there are sufficient assets to fund the marital trust exemption of 12.06 million dollars in 2022. If all assets are held jointly with rights of survivorship, the joint assets would pass directly to the spouse and no exemption would be utilized.

Assets placed in a credit shelter trust remain tax-free even if they increase in value. On the death of the surviving spouse, the value of the trust assets won’t be included in his or her estate. One benefit of the marital gift trust is that the surviving spouse is not required to take income distributions on an annual basis. Instead, the principal remains intact, which may increase the trust’s overall value for all parties.

The rub is capital gains on the assets. The value of the assets will continue to grow during the remaining spouse’s lifetime and eventually will be taxable to heirs. This is an issue that your CPA can advise you on.

Portability has changed marital estate planning by allowing more options. It may be better to create a marital gift of credit shelter trust on the first death and not use the deceased spouse’s exemption. By porting, the survivor will have the benefit of two estate tax exemptions to shelter the assets from any estate tax. If the first spouse to die does not use the entire estate exemption, Form 706 is required to be filed with the IRS if a portability election is desired even if no requirement to file exists.

Dividing property between the marital gift and credit shelter trusts is required only if the decedent left a surviving spouse and the estate more than the current estate exemption of 12.06 million.

Careful estate planning can eliminate a significant estate tax burden for surviving spouses and their beneficiaries. Credit shelter and marital gift trusts can be useful tools in preserving an estate’s assets. Determining which option is best in a given situation depends on the amount of control desired by the original donor and the income needs of the surviving spouse.

The number of trusts is increasing primarily for tax purposes, which means your chances of being asked to be an executor or trustee is growing too. While technology has made trust information easier to deal with, it still wouldn’t hurt if you turn to a CPA who’s in a unique position to provide professional services as you deal with the estate or trust. Your accountant can interact with lawyers, financial planners, other CPAs, insurance agents, realtors and members of the decedent’s family. Give the office a call.

Have Questions?

If you need assistance or have any questions on the information in this article, please call your CironeFriedberg professional. You can reach us by phone at (203) 798-2721 (Bethel), (203) 366-5876 (Shelton), or (203) 359-1100 (Stamford) or email us at info@cironefriedberg.com.

Filed Under: Estate & Trusts, Individual Taxes Tagged With: estate planning, marital gift trust, real estate, taxes

Home Sellers’ Profit Exclusions Aren’t One-Time Opportunities

November 23, 2022 by David Moseman CPA

happy older couple sitting in front of sold house

The tax code authorizes “exclusions” that allow home sellers to completely sidestep federal and state income taxes on sizable portions of their profits when they unload their principal residences. The profit exclusions are as much as $500,000 for married couples who file joint returns and $250,000 for single filers and couples who file separate returns. So says Julian Block, an attorney and former IRS special agent.

Contrary to what many sellers mistakenly believe, the exclusions aren’t one-time opportunities. They can avail themselves of the exclusions as often as every two years.

The law allows a seller we’ll call “Louise” to qualify for the exclusion only if she satisfies two requirements:

  1. She has owned and lived in the property as her principal residence or main home for at least two years out of the five-year period that ends on the date of sale.
  2. She can’t have excluded the gain on the sale of another principal residence within the two years that precede the sale date.

An accommodating Internal Revenue Service cuts Louise some slack on the two years that she occupies the home. The two years don’t have to be consecutive; they can actually be off and on for a total of two full years.

What about short temporary absences for vacations or other seasonal absences? No problem, says the IRS. It’s OK for Louise to count them as periods of owner use. This holds true even if she rents out the property during the absences.

The IRS doesn’t limit exclusions to sales of conventional single-family homes. It considers Louise’s principal residence to be any of the following:

  • A condominium.
  • A cooperative apartment.
  • Her portion of a multi-unit apartment building.
  • A house trailer.
  • A mobile home.
  • A houseboat or yacht that has facilities for cooking, sleeping and sanitation.
  • A vacation retreat that she moves into full time after retirement.

Another plus: The location of her principal residence doesn’t matter. It can be outside the U.S.

Partial profit exclusions. Suppose Louise sells another home within the previous two years or fails to satisfy the ownership and use requirements; all is not lost. She may be able to claim a partial exclusion.

Primary reasons for sales. The IRS permits sellers to avail themselves of reduced exclusions only when the primary reasons are health problems (for example, if Louise moves to a new school district for her special-needs child); changes in employment; or certain unforeseen circumstances, broadly defined to include divorces or legal separations, or natural or man-made disasters that cause residential damage — floods, for example.

An example: Louise is single and has lived in her dwelling for just 12 months before she moves to a new job in another city. She can exclude a gain of as much as $125,000 — 12 months divided by 24 months, or 50% of her maximum allowable $250,000 exclusion.

The bottom line? Don’t make assumptions about what you may or may not be allowed to deduct. Work with a tax professional to make sure you get everything you’re entitled to claim.

If you need assistance or have any questions on the information in this article, please call your CironeFriedberg professional. You can reach us by phone at (203) 798-2721 (Bethel), (203) 366-5876 (Shelton), or (203) 359-1100 (Stamford) or email us at info@cironefriedberg.com.

Filed Under: Individual Taxes Tagged With: home sales tax, profit exclusions, real estate

Tax Breaks for Older Couples Who Sell Their Homes

July 29, 2022 by David Moseman CPA

happy older couple with house

Consider Irene, who recently became a widow when her husband, Henry, passed away. Like most married couples, they held the title to their home in joint ownership with the right of survivorship. In plainer language, this means that co-owner Henry’s death results in his loss of all ownership in their dwelling. Surviving co-owner Irene automatically acquires all ownership in it.

Irene is uncertain what to do with her highly appreciated home. One option is to quickly sell it and move to where her daughter lives. But Irene should go slowly when it comes to major decisions such as home sales. Other options are to wait several years and then sell, or just stay put, in which case the residence would eventually wind up with her heirs.

Irene wants to know the tax consequences of selling or staying. First, she needs to understand the tax breaks for individuals who sell their principal residences.

Exclusions. The law authorizes “exclusions” that allow home sellers to sidestep income taxes on most of their profits when they unload their principal residences. The profit exclusions are as much as $500,000 for couples filing joint returns and as much as $250,000 for single persons. Sellers are liable for taxes on gains greater than $500,000 or $250,000.

Irene decides to sell. Can she exclude $500,000 or $250,000? The answer depends on the sale date and whether she remarries. Though she’s no longer married, recently widowed Irene still qualifies for the higher amount — as long as she sells within two years of Henry’s death. It’s the lower amount if she sells after the two-year deadline.

Irene remarries. If her new husband, Steve, then lives in the place as his principal residence for at least two years out of the five-year period that precedes the sale date, the profit exclusion will once again be $500,000.

Usually, a seller also has to own the place for those two years. That requirement doesn’t apply to Steve. That means his name doesn’t have to be on the title.

Moreover, the IRS says that Irene and Steve needn’t be married for all of the two years that precede the sale date. What do they need to do before the sale occurs? Just marry. This holds true even if their wedding precedes the sale by just one day.

Even if Irene doesn’t remarry — and even if she doesn’t sell within two years of Henry’s death — her taxable gain may be smaller than she fears. Suppose, as is likely, that Irene’s long-term capital gain profit from her home’s sale exceeds her exclusion ceiling and she’s liable for taxes on the gain.  

Tax rates for long-term capital gains. For most sales, the tax rate usually is 15%, increasing to 20% for lots of high-income sellers. It goes as high as 23.8% for those who are in the top income tax bracket of 37% and subject to the Medicare surtax of as much as 3.8% on income from certain kinds of investments, including profits from home sales.

State income taxes. On top of Uncle Sam’s take, state income taxes may also be owed. I caution Irene that she might not be able to deduct all those taxes.

The Tax Cuts and Jobs Act. This legislation imposed a $10,000 ceiling on write-offs for state and local income and property taxes. Another snag: Irene forfeits any write-off for state income taxes if she’s subject to the alternative minimum tax.

Step-up in basis. While my recitation of federal and state tax rates dismays her, Irene is pleased to get some good news that the government authorizes exceptional condolence gifts for Irene and other bereaved individuals who sell inherited homes, stocks and other assets that have appreciated in value. In tax lingo, the basis (the starting point for measuring gain or loss) of inherited assets “steps up” from their original basis (the cost upon purchase, in most instances) to their date-of-death value. It’s as if the inheritors had bought the assets that day.

On Henry’s death, a step-up in basis for their home benefits Irene when she sells her dwelling. What happens if she never sells? On Irene’s death, there’s a second step-up in basis that benefits her heirs.

The first step-up is only for Henry’s half interest. There’s a step-up of his adjusted basis (typically, half the original purchase price and half the cost of any subsequent home improvements) to what that half-interest is worth when he dies. If the couple lived in a community property state, the step-up is for the entire basis.

On Irene’s death, there’s a step-up of her adjusted basis (previously boosted by the step-up for Henry’s half interest) to what the entire home is worth when she dies. When the heirs sell the home, they’re liable for capital gains taxes only on post-inheritance appreciation.

For more information on this topic, read our article Capital Gains and Home Sales.

The bottom line for Irene and her heirs: Whereas a sale by Irene of a home that has appreciated immensely can trigger sizable federal and state taxes, a sale by the heirs dramatically shrinks or even erases those taxes. Irene—and others in similar positions—should work with tax and estate planning professionals to ensure they’re making the best decisions for their long-term future plans.

 

If you need assistance or have any questions on the information in this article, please call your CironeFriedberg professional. You can reach us by phone at (203) 798-2721 (Bethel), (203) 366-5876 (Shelton), or (203) 359-1100 (Stamford) or email us at info@cironefriedberg.com.

Filed Under: Individual Taxes Tagged With: capital gains, estate, estate tax, homesale, profit exclusions, real estate

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