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Flustered by Finances? A tale of Taxes and titles

Flustered By Finances? Ask Ellen

A Tale of Taxes and Titles

One of our members asks…

I heard that as a power of attorney for my parents; if my name (or siblings) is put onto their investments /properties, etc that when they pass I (and siblings) wouldn't have to pay inheritance tax. Is this info correct? Is there a period of time that this needs to be done in order for this to be in effect?

This question is a good question since it brings up several topics. First, let me clarify that whether or not a child is designated as a power of attorney for a parent is irrelevant to the discussion regarding asset ownership and taxation. Anyone can hold a power of attorney for anyone else and it is a legal designation that applies only during a parent’s lifetime and ends at their death.

Now let’s review the basics about inheritance tax since lots of people confuse inheritance tax with estate tax. They are both assessed on assets after death but accomplished quite differently. Just a handful of states impose an inheritance tax at death and the tax is paid by the individual who inherits the assets.Delawaredoes not have an inheritance tax andPennsylvaniadoes. In Pennsylvania spouses are exempt from inheritance tax, but children will pay at the rate of 4.5% on assets greater than $3,500.

A slightly larger handful of states have an estate tax. An estate tax is assessed on the entire estate before assets are distributed.Pennsylvaniahas none, andDelawaredoes but only on estates that exceed $5,250,000. So, for most Delawareans, there is no state estate tax or inheritance tax assessed on their assets when they die.

Now that we cleared any confusion around state estate tax versus inheritance tax, members may wonder if it makes sense to transfer parental assets into a child’s name so as to avoid federal estate taxes. Just like Delaware’s state estate tax, the federal estate tax threshold is $5,250,000. For people with large enough estates to worry about taxes, they should work with a trust and estate attorney to develop a plan for reducing taxes at death. The several thousand dollars spent will be worth every penny.

There is no time restriction for transferring assets from a parent’s name to a child’s name to make it legal and effective. (Our questioner may be thinking about the five year “look back” period that states impose on asset transfers before someone can qualify for Medicaid.)

Here are a few reasons why you should seriously think aboutnottransferring title of assets from a parent to a child:

  1. Capital Gains Tax: Typically financial assets and real estate would have been bought years ago at a lower cost. When assets are transferred to a child before death, the child assumes the same low cost basis. Therefore, when they sell the assets they may face a large capital gain and subsequent large tax. If, on the other hand, the assets pass to the child after the death of the parent via a Will or Trust, the assets get, what’s called, a “step-up” in cost basis, and the assets assume the cost basis as of the date of death of the parent. This could help avoid a large tax hit.

  1. Home Sale Tax Exclusion: If your parent transfers title of her home to you and you subsequently sell it to get cash, you lose out on the generous $250,000 ($500,000 for married capitals) capital gain exclusion (if you haven’t owned and lived in the home for at least 2 out of the last 5 years).

  2. Loss of Control: Think about if your parent would be comfortable relinquishing control of their assets. Do they really want their child to have the ability to decide if and when they should sell their home?

  3. Outside Parties: What about in the case of a child getting a divorce? An ex-spouse could have a legitimate claim against the child which could also include the parent’s assets.

Here’s an example:

In 1997 Herman and Ethel bought their home for $150,000. It’s now worth $500,000. Herman passed away two years ago and Ethel and her son, Robert, agree that Ethel should move to an assisted living facility. Robert and Ethel decide to transfer title from Ethel to Robert (the $150,000 cost basis transfers to Robert) to get the home out of Ethel’s estate and avoid taxes. In 6 months they get a cash offer for the home for $500,000, an offer they can’t refuse. Robert will owe capital gains taxes on $350,000 of gain, which in his tax bracket equates to 15% tax or $52,500. If Ethel had kept her home in her name and subsequently sold it, only $100,000 of her $350,000 gain would have been potentially taxed. If she was in a low enough tax bracket she might not be liable for any taxes at all since there is no capital gain taxes assessed for those in the 10% or 15% tax brackets.

Another scenario could be that Ethel wouldn’t need the money from her home to help pay for her assisted living entry fee. Instead, Robert and his wife insist that she move in with them! Ethel decides to hold onto her home and Robert agrees to manage it as a rental property. But they still determine that they should transfer title to Robert (the $150,000 cost basis transfers to Robert) to get the home out of Ethel’s estate and avoid taxes. When Ethel passes away ten years later her home is worth $600,000. Meanwhile, Robert’s family has grown, concomitant with huge upcoming college expenses, and his job is tenuous. He decides to sell the rental property to ease his cash flow. He is liable for a $67,500 tax (15% of $450,000 of gain). If, instead, he had inherited the home from his mom, he would have received a step-up in cost basis to $600,000. The sale would have realized zero capital gain and zero tax.

In summary, it typically is best to let a child inherit a parent’s property. Pennsylvania’s 4.5% inheritance tax for property passed to children is really not too onerous. Delaware doesn’t have any inheritance tax, and unless your estate is very large, the Delaware estate tax won’t apply.

If your parent’s estate is over 5 million dollars your smartest move is to hire an experienced trust and estate attorney to review with you and your parent the best estate planning scenarios. Have your ducks in a row before you meet: what are you and your parent trying to accomplish? And who should receive which assets? The more thinking you do before meeting with your attorney could mean fewer billable hours.

Please send Ellen your financial questions, concerns, dilemmas, etc.Her column functions best when it addresses your personal issues. You will not be identified by name! Email Ellen atWilmingtonChapter@hadassah.orgwith “Ask Ellen” in the subject line. Ellen’s answers will appear in her “Flustered By Finances?” column in our bulletin and/or on our chapter website.

Ellen Le

Ellen will consider all legitimate questions and prioritize those of broadest concern. Please be patient if your question is not answered immediately. Email your questions to:WilmingtonChapter@hadassah.orgwith Ask Ellen as the subject. If Ellen selects your question, it will appear in her “Flustered By Finances?” column in the bulletin and/or on her webpage on our website.

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