Inherited house and step up in basis

[hntrust]

My daughter's, husband's grandparents died in 2015 and 2016. His mother inherited their home after the estate was probated in Maryland. The deed was transferred to her name in 2017 and we just found out that she at the same time added my son-in-law on the deed as joint owner with right of survivorship. We are concerned that she got some bad advice since the home's value in 2016 was approximately $450,000 and it is now in 2023 approximately $700,000. Are we correct in that when the MIL dies that my son-in-law's cost basis will be the same as when his mother inherited the house at $450,000? Then when he goes to sell the house will he owe capital gains taxes on the difference between the value at her death and his cost basis of $450,000? How can my daughter and son-in-law avoid this so that he would get a step up in basis when his mother dies?

[Mike9241]

mother inherits house and gets step up to FMV.  she gifts 1/2 of house to her son who gets 1/2 of her basis. when she dies and the son inherits her half. his basis would be 1/2 the original basis he had from the gift + 1/2 the FMV on the date of his mother's death. 

so his basis would be 1/2 the $450,000 and 1/2 the $700,000 if that's the fair market value on the date his mother dies. if he sells for the $700K his gain would be $125K less s selling expenses. 

see a lawyer but it seems the son would have to be removed from the title which would likely constitute a gift to his mother for which a gift tax return would be required. There would likely be costs involved which the lawyer could explain to you. for example, if the son is removed from the title, ownership of the house would likely need to be probated.  

[tagteam]

@Mike9241 is essentially correct with respect to the son-in-law's basis when his mother passes.

Please consult with local counsel as the current schema can be ameliorated. 

https://www.avvo.com/estate-planning-lawyer.html

[hntrust]

I found this. Do you interpret it to agree with what Mike said?

https://www.law.cornell.edu/uscode/text/26/2040

[tagteam]

That Code section concerns the value of the gross estate. 

In most instances, that value includes any property the decedent owns in joint tenancy with another party and, typically, that would be 50% of property owned as JTWROS (i.e., 50% receives a stepped-up basis).

[Opus 17]

The default situation is as @Mike9241 calculated.

If there was an expressed understanding that the home was being put in the son's name only for purposes of simplifying inheritance, and the mother had the right to live there until she died and the son has no rights before then, there might be an implied life estate.  With a life estate, the heir inherits a full stepped up basis.

Most of the time, life estates are in writing.  An implied life estate is valid, but can be difficult to prove if the son is audited, especially if the son didn't even know what was happening at the time, and can't produce letter or emails proving the mother's intentions.

If the mother is still alive and competent to make legal decisions, she and her son should talk to an attorney, especially one with a practice in elder law and estate planning.  There are ways to make the life estate clear in writing.  (I'm not going to suggest them because if they do it on their own based on free internet advice and something goes wrong, they could be in a worse position.).  There are also steps they could take to protect the home and the mother's other assets if she is unlucky enough to need expensive long term medical care, so the son can inherit something instead of being forced to spend all the estate on medical care. 

[hntrust]

I'm thinking that the JTWROS deed was used to avoid probate when the mother dies. The deed was created by the attorney who probated the grandfather's estate in 2017. I think that the son needs to go back to the attorney and ask if a life estate was the intent and if so how does the son prove that if he were to get audited by the IRS for failure to pay the capital gains tax sometime in the future after mom died and he sells the house.

[Opus 17]

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@hntrust wrote:

I'm thinking that the JTWROS deed was used to avoid probate when the mother dies. The deed was created by the attorney who probated the grandfather's estate in 2017. I think that the son needs to go back to the attorney and ask if a life estate was the intent and if so how does the son prove that if he were to get audited by the IRS for failure to pay the capital gains tax sometime in the future after mom died and he sells the house.

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While JTWROS does avoid probate, it may not be the best tax strategy.  If you have a JTWROS in writing, that would seem to completely rule out a life estate, implied or otherwise.  One of the difference, if I understand correctly, is that with a life estate, the "remainderman" has an ownership interest but has no real limited rights until after the owner dies (the remainderman can't sell their interest to someone else, for example).  With JTWROS, either party has the right to sell their share to a third party without the permission of the other--for example if your son-in-law wanted to cash out of the house now, he could sell his half to an investor would would then be the new co-owner with his mother.  

I would go back to the lawyer, or go to a different lawyer, and present the whole problem.  Not just "how do I give my house to my son without probate," but "how can I best protect my assets so my son inherits as much as possible with as little legal trouble as possible, with minimum tax consequences, including planning for some way to protect my son's inheritance if I require long term medical care or have other unexpected life events."

[hntrust]

Thank you for those excellent questions to ask the attorney.😊

[tagteam]

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@hntrust wrote:

Thank you for those excellent questions to ask the attorney.😊

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If you are in one of the states listed below, ask your attorney about a Lady Bird deed (enhanced life estate).

I understand that the deed (most likely a quitclaim deed) was written as JTWROS with your son-in-law's mother as the grantor and she and your son-in-law as grantees, but they may be able to show that was a mistake and that a life estate was the intent. The foregoing will achieve the desired result.

Florida, Michigan, Texas, Vermont, West Virginia

[tagteam]

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@Opus 17 wrote:
.......if I understand correctly, is that with a life estate, the "remainderman" has an ownership interest but has no real rights until after the owner dies. 

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A remainder is a future interest in property and rights attach to that interest, including the right to prevent waste on the property and compel payments to keep the property free from liens. A remainderman can also prevent the life tenant from selling (or otherwise alienating) the property (except with respect to an enhanced life estate).

Further, a remainder interest is reportable as a gift if there is no consideration given for the interest and the value of the interest is not reduced by the annual gift tax exclusion.

[Opus 17]

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@tagteam wrote:

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@Opus 17 wrote:
.......if I understand correctly, is that with a life estate, the "remainderman" has an ownership interest but has no real rights until after the owner dies. 

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A remainder is a future interest in property and rights attach to that interest, including the right to prevent waste on the property and compel payments to keep the property free from liens. A remainderman can also prevent the life tenant from selling (or otherwise alienating) the property (except with respect to an enhanced life estate).

Further, a remainder interest is reportable as a gift if there is no consideration given for the interest and the value of the interest is not reduced by the annual gift tax exclusion.

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I updated it to "limited rights."

Good reminder about the possibility that the mother might have been required to file a gift tax return in 2017. 

[hntrust]

Thanks about the reminder for a gift tax return. Isn't the gift tax exclusion equal to the estate tax exclusion? I also posted my original post here on a Facebook group. A well known estate planning attorney responded:

"There are many reasons not to add a joint owner, so she probably got poor advice in that regard. However, the basis isn't one of them. The entire property will be included in her estate under Section 2040(a), https://www.law.cornell.edu/uscode/text/26/2040, so that he'll get a new basis."

[Opus 17]

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@hntrust wrote:

Thanks about the reminder for a gift tax return. Isn't the gift tax exclusion equal to the estate tax exclusion? I also posted my original post here on a Facebook group. A well known estate planning attorney responded:

"There are many reasons not to add a joint owner, so she probably got poor advice in that regard. However, the basis isn't one of them. The entire property will be included in her estate under Section 2040(a), https://www.law.cornell.edu/uscode/text/26/2040, so that he'll get a new basis."

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I'm going to give up here.

I've found some documents (from internet sources with more or less credibility) that discuss IRC section 2040 in combination with section 1014.  They are not all on point (many deal with spousal transfers).  But it appears that section 2040 and section 1014 work together to say that, if the joint tenants paid for their shares, the basis of the survivor's share is not adjusted and the basis of the share they inherited is stepped up.  But if one of the joint tenants paid zero for their share (i.e. it was a gift), then the entire property receives a stepped up basis. 

There is also an obscure example in publication 551 that seems to support this argument, although it is hard to interpret.

Some sources also seemed to suggest that inheriting a property under JTWROS triggers a requirement to file a gift tax return at the time of the giver's death, rather than when the joint tenancy was established by deed.

As this contradicts a lot of what I have believed over the years, I need to declare my ignorance and send you (or your son-in-law) to an attorney.  I still think that, even if the son would receive a fully stepped up basis under the current arrangement, there may be other benefits to modifying the arrangement after appropriate elder law and financial planning.  

[tagteam]

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@Opus 17 wrote:

......if one of the joint tenants paid zero for their share (i.e. it was a gift), then the entire property receives a stepped up basis. 

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Actually, that would be correct per Section 2040 (unless the property was held by the decedent and the decedent's spouse as TBE or JTWROS).

I virtually never see transactions (transfers), other than on this board, where parties other than two spouses end up holding title as JTWROS or TBE (and non-spouses cannot hold title as TBE). As a result, it's became a knee-jerk reaction to reach the conclusion outlined in earlier answers in this thread. 

Regardless, the current status is far from optimal, particularly if there are other potential heirs who would effectively be disinherited by the manner in which title is being held.