Forget all the articles you have read about whether you should convert to a Roth IRA.  Forget about “Roth IRA Conversion Calculators.”  If you have a substantial amount in a retirement plan that can be converted to a Roth IRA, you should convert this year.  I am confident about this because my son, Ethan Okura, and I have developed a technique for converting to a Roth IRA in a special way which greatly reduces income taxes in the conversion.

Before I explain the technique, let me do a quick review of the advantages of a Roth IRA.  “Qualified distributions” from a Roth IRA are completely tax free.  A qualified distribution is one made more than 5 years after January 1^st of the first year in which you made a contribution to any Roth IRA, and which is made after you are 59 ½ years old, or after death.  With a Roth IRA, you don’t have to start taking out distributions when you are 70 ½ years old.  The entire Roth IRA can keep growing tax free for your entire life.  Then, after your death, the Roth IRA can be distributed to your child, grandchild, or other loved one, over her life expectancy, completely tax free, while the balance still in the Roth IRA can keep growing tax free during your beneficiary’s lifetime!  There is nothing more free of income taxes than a Roth IRA.

The following can be converted into a Roth IRA:  a traditional IRA, and, subject to the terms of the retirement plan, a 401(k), profit sharing plan, 403(b), deferred compensation plan, and inherited 401(k).  Until this year, a person with a modified adjusted gross income of more than $100,000 was not allowed to convert to a Roth IRA.  From January 1, 2010, anyone can convert to a Roth IRA, no matter how large your income.  I suggest doing it before the window of opportunity closes.

The main reason people hesitate to convert to a Roth IRA is that the assets converted to a Roth IRA will be taxed.  The technique which we have developed greatly reduces the taxes.  The basic idea is one that we estate planning attorneys have been using for many years: limited partnerships or LLCs.  The new creative twist is in applying a proven estate planning technique to the area of Roth IRA conversion.

First, we change the traditional IRA into an IRA that is permitted to invest in LLC shares, real estate and other investments besides stocks and bonds.  If you would like to have your IRA invest in real estate, it can be done!  If you prefer to have your IRA keep investing in stocks, bonds and mutual funds, we have the stocks, bonds and mutual funds owned by a business entity such as an LLC.  We have your IRA own LLC shares.  We structure the LLC documents and the ownership arrangement in such a way that a “valuation discount” is justified.  A valuation discount is an artificial but legal reduction in value of assets for appraisal purposes.  The discount can be anywhere from 40% to 70%.  For example if the valuation discount turns out to be 70%, that means that you can convert $1,000,000 worth of assets in a traditional IRA to a Roth RIA, and legally report to the IRS that $300,000 of assets were converted, so that you only have to pay tax on the $300,000.  The other $700,000 would be converted to the Roth IRA tax free.

Do not try to do this yourself.  There are very technical rules about “prohibited transactions,” which, if violated, can cause serious tax problems.  There are only a handful of attorneys in the State of Hawaii knowledgeable about prohibited transactions.  My son Ethan Okura will be putting on an educational seminar on this technique in Honolulu on July 23^rd and 24^th, 2010.  You can reserve a seat by phoning the Honolulu Office of Okura & Associates.

Let me first explain the history of the Hawaii inheritance tax and the Hawaii estate tax.  An estate tax is a tax on the property of someone who has died.  The federal death tax is an estate tax. An inheritance tax is a tax on property that is inherited by each beneficiary or heir.  When I first became an attorney in 1976, there was a Hawaii inheritance tax.  I remember preparing Hawaii inheritance tax returns.  Then Hawaii adopted The Estate and Transfer Tax Reform Act of 1983.  When this law was adopted, the Hawaii death tax became an estate tax.  Hawaii’s estate tax was called a “pick-up tax.”  It allowed the State of Hawaii to pick up (or collect) for itself part of the estate tax which the federal government could collect.  The amount that Hawaii could collect was the maximum amount that the federal government allowed as a credit for state death taxes against the federal estate tax.  Later, the federal government passed the Economic Growth and Tax Reconciliation Act of 2001.    This tax act phased out the state death tax credit at the rate of 25% a year starting in 2002.  This meant that the amount of the federal death tax which Hawaii got to keep was reduced each year, until it became zero.  Since 2005, there has been no Hawaii death tax, until now.

The new Hawaii estate tax law is poorly written.  It would be difficult for someone to understand the new law without doing some tax research and without knowing the history of the federal estate tax and the Hawaii estate tax.  When you first read the new law, it sounds like the tax only affects nonresidents who are not citizens of the United States.  After researching the federal and state tax laws referred to, you realize that the new law affects Hawaii residents and citizens as well.

It appears that under the new law, there will be no Hawaii estate tax to pay unless you die with a taxable estate of more than $3,600,000.  Although the new law allows a $3,500,000 tax free amount, when you actually calculate the tax, another $100,000 is tax free, for a total of $3,600,000.   For the first $50,000 over $3,600,000, the tax rate is only .8%.  For those who die with a taxable estate of more than $10,100,000 the tax rate goes as high as 16%.

If a married person with an A-B trust with more than $3,600,000 dies in 2010, since there is no federal estate tax this year, the entire estate would go into the B trust, and nothing would go into the A trust (the marital trust). Everything going into the B trust in excess of $3,600,000 would be subject to the new Hawaii estate tax.  Some or all of that tax could be avoided by changing the trust to cause some assets to go into the A trust.  In 2011 or later years, under current law only $1,000,000 will be exempt from the federal estate tax but $3,600,000 will be exempt from the Hawaii estate tax.  Depending on the size of the estate, there may be tax savings by arranging the estate plan so that some tax is paid when the first spouse dies, instead of deferring all taxes until the second spouse dies.   Anyone with assets large enough to be taxed should have their estate plan reviewed to see if any changes are warranted as a result of the new Hawaii estate tax or the reduction in 2011 of the federal tax free amount to only $1,000,000.

Last month and the month before, I explained how to protect your home from Medicaid liens.  In my April column, I described how a parent can transfer the family residence to the children, and keep a “life estate.”

The life estate allows the parent to continue to live in the home for life.  If the parent goes into a nursing home and receives Medicaid help, the government can still put a Medicaid lien on the property.  The lien is like a mortgage.  The government uses it to secure repayment of all the payments it made to the nursing home on behalf of the Medicaid recipient.  However, the Medicaid lien attaches only to the life estate.  When the parent dies, the life estate disappears.  The children then receive the property free and clear of the lien.  I know this works.  Our law firm has used this technique for hundreds of clients.  When the client passes away with a Medicaid lien on the life estate, we contact the Attorney General’s office, prove to them that their lien was only on a life estate and that the life estate holder has died, and ask them to remove the lien.  So far we have been successful 100% of the time.

Some people have concerns about the life estate.  I will now discuss some of these concerns.  Suppose mother transfers the residence to daughter and reserves a life estate.  What happens if the daughter dies first?  The first problem is that if the daughter dies, her ownership interest in the residence will have to go to court for probate.  That problem is easily solved.  Instead of having mother transfer the property directly to her daughter, have the daughter first set up a Revocable Living Trust for herself.  Then mother can transfer the property to her daughter’s Revocable Living Trust, and keep a life estate for herself.  If the daughter happens to die first, there will be no probate.

A more serious problem is this:  what if the daughter dies first and her share of the property goes to her husband, who remarries? When he dies, it goes to his new wife instead of to the grandchildren.  Or what if the daughter has a car accident and is sued, or has serious financial problems or goes through bankruptcy?  The daughter’s share of the property is taken away by a creditor, and when mother dies, the property goes to the creditor. Or what if the daughter gets a divorce, and the divorcing husband tries to go after part of the property?

Don’t worry!  There is a way to protect against these problems.  This is what you can do.  Instead of transferring the property directly to your son or daughter, set up an irrevocable trust.  Your son or daughter can be trustee of the irrevocable trust.  You transfer your property to the irrevocable trust, but keep a life estate.  The irrevocable trust can say that if your daughter dies before you, the property goes to her children rather than to her husband.  The trust can also protect the property from divorce.  The irrevocable trust can also say that if the son or daughter is sued, the person suing the son or daughter cannot touch the property in the irrevocable trust.  The parent can safely live in the house all of his or her life.  When the parent dies, then the property is transferred from the irrevocable trust to the child or children inheriting the property.  If you prefer, the trust can be a “generation skipping trust” and keep protecting the property for the child in case the child gets a divorce or dies with lots of assets.

If you have been afraid to use the life estate technique because child might die, get divorced, or be sued, there is no need to worry.  You can transfer your residence to an irrevocable trust, keep a life estate, and sleep peacefully at night.

OKURA & ASSOCIATES, 2010

ESTATE PLANNING ATTORNEYS

Last month we discussed the dangers of having the government put a Medicaid lien on your home and property if you end up in a nursing home.  Remember, a “revocable living trust” cannot protect your home from nursing home costs.

Some senior citizens who are worried about Medicaid liens just give the house to the children.  I do not think this is wise.  There are many cases in which the parents gave the home to the children, then the children kicked the parents out of the home!  Even if your own child would never kick you out of your home, maybe your son-in-law or daughter-in-law would.

There was a case in Honolulu in which an elderly father and mother had only one son.  The son was married but had no children.  The parents went to a lawyer  and gave their home to their son.  They kept living in the house.  The son and his wife got into a terrible car accident.  The son died first.  Then the son’s wife died.  When the son died, the house went to his wife.  When the wife died, the property went to her parents!  Her parents lived in Germany.  The couple in Germany sold the house!  The elderly couple in Hawaii were kicked out of their own home in their old age!  Because of cases like this, I do not recommend that you just give your property to your children.

In my opinion, the best way to protect your home from Medicaid liens is to give the property to your children, but to keep a “life estate.”  Keeping a “life estate” means that you legally own the property as long as you are living.  Nobody can kick you out.  Yet, you have legally given away a “future interest” in the property to your children.  This means that your children already own the property now, but cannot use it while you are living.  If you were to pass away, the children would automatically be the full owners of the property.

If you give your home to your children (or other loved ones), but keep a life estate, these are some of the consequences:  1) you cannot take the property back unless your child agrees; 2) you cannot mortgage or sell the property unless your child agrees; 3) if you do sell the property while you are living, you will get only part of the money from the sale, and your child will get part of the money; 4) when you die, the value of the property will be counted with your other assets to see if you have more than $1 million (if you do, there may be an estate tax.)  5) If you apply for Medicaid within 5 years, there will be a penalty period ( a period of time during which Medicaid will not pay nursing home costs).

There are several advantages to giving away your property while you are living, but keeping a life estate:  1) you will still be entitled to the homeowners exemption from property tax; 2) you can live in your home for the rest of your life; 3) there will be no probate of your home when you die; 4) a Medicaid lien cannot take the property away from your children; 5) when you die, the property gets a “stepped up basis” so that if your children sell the property, they will pay little or no capital gains taxes (because of the 2001 Tax Act, there will may be no stepped up basis if you die in the year 2010.)

If you already have your property in a revocable living trust, you can still use the life estate technique.  You just take the property out of your revocable living trust, put it back in your own name, then give it to your children, keeping a life estate.  If more senior citizens did this, more children would be protected from Medicaid liens on the family home.

OKURA & ASSOCIATES, 2010

More and more senior citizens are becoming concerned about nursing home costs.  No one really wants to go to a nursing home.  Nearly every elderly person would prefer to stay at home.  However, no matter how much children love their parents, caring for an elderly parent at home can be so stressful that a stay in a nursing home often becomes necessary.  A Kaiser Family Foundation Survey in 2003 found that if you are 65 years of age or older, there is a 45% chance that you will spend some time in a nursing home.  The average nursing home stay is 2.4 years.

Medicaid is the most common way of paying for nursing home costs.  When you apply for Medicaid for nursing home costs, they will count your assets to see if you qualify.  They do not count the value of your home.  However, there is a trap here.  Even though the Medicaid rules say that your home is an “exempt” asset which is not counted when you apply for Medicaid, once you are on Medicaid, they may be able to put a lien on your home.  A lien is like a mortgage.  It will guarantee that the government will be paid back money that they pay for your nursing home costs.

For example, suppose you have to spend the last 3 years of your life in a nursing home.  Suppose you have very little in assets besides your home.  Medicaid pays your nursing home bills, but puts a Medicaid lien on your home.  At a cost of $9,000 per month, your nursing home stay could cost $324,000!  After you pass away, you owe to the government the entire amount they paid for you.  The government will approach your children who are hoping to inherit the home.  They will give your children a chance to go to a bank to borrow the money to pay off the amounts Medicaid paid for your nursing home costs.  If your children want to keep the home, they are forced to buy it.  If they cannot afford to do that, the government could sell the home, and keep the proceeds from the sale, up to the amount that is owed to them.  If there is any money left over after all expenses, your children get to keep the extra.

Because of the great danger of losing the home to nursing home costs, it becomes important to understand how you can protect your home from Medicaid liens.  The first thing to remember is that a Revocable Living Trust will not protect your home from nursing home costs!  This is one of the most common misunderstandings.  Many people have a “living trust” and think they are safe.  A living trust (also called Revocable Living Trust) will protect your assets from probate, but it will not protect from nursing home costs.

The government will not place a lien on your home as long as your spouse is living in the home.  The danger is that the spouse who is living in the home could die first, or also end up in a nursing home.  Then the home is no longer protected from Medicaid liens.  This kind of problem can be prevented by advance planning.  In my opinion, the best method for protecting the home from nursing home costs is for the parents to give the home to the children, but to keep a “life estate.”  A “life estate” means that the parents can live in the home for the rest of their lives.  Yet, they have given the home to the children.  (For those of you who do not have children, I apologize for always talking about children.  This technique will work just as well with a niece or nephew or anyone else you choose to inherit your home.)  In next month’s column, I will explain in more detail how this life estate method works.

OKURA & ASSOCIATES, 2010

There is no federal estate tax this year.  Since the State of Hawaii has no inheritance tax, Hawaii residents can die this year with any amount of assets and pay no death taxes at all.  This is only for the year 2010.  For someone dying in 2011 or later years, any assets not inherited by a spouse or a charitable organization will be taxed, starting at a tax rate of 41% from the first dollar over 1 million, and going up as high as 55% for amounts over 3 million dollars.

The strange law this year and next year is a result of the 2001 tax act.  The 2001 tax act was supposed to get rid of the estate tax.  The 2001 tax act provided that the amount exempt from estate taxes would be $1,000,000 in 2002 and 2003, $1,500,000 in 2004 and 2005, $2,000,000 in 2006, 2007 and 2008, $3,500,000 in 2009, with no estate tax at all in 2010.  However, the bill that passed Congress contained a “sunset clause.”  The sunset clause provided that unless Congress in the future voted to extend the law, this new tax law would expire after December 31, 2010.  Like Cinderella’s beautiful carriage turning back into a pumpkin, just after midnight on December 31, 2010, the tax law will go back to what it was in 2001, which was that only 1 million dollars is exempt from the estate tax.  Therefore, there is no estate tax, but only for this year.  Remember, however, that Congress and the President can change the law again at any time.

Another important change is in the law regarding the stepped up basis.  (See my October 2009 Estate Planning Insights column about the stepped up basis.  You can find a copy in my blog at www.okuralaw.com.)  The usual stepped up basis rules do not apply in 2010, but will again apply starting January 1, 2011.  The 2010 basis rules are called the “Modified Carry-over Basis” rules.  If a person dies in 2010, the tax basis in the property will be the lower of the basis before the person died, or the fair market value at date of death.  However, the executor can increase the basis of assets owned at death up to the lesser of fair market value or 1.3 million dollars, plus up to the lesser of fair market value or 3 million dollars for property passing to a surviving spouse.  To qualify for the increase in basis, the property has to be in the name of the person who dies, or in her revocable living trust.  Although some experts differ on this issue, it is my opinion that property in which a person dies in 2010 with a life estate will not get a step up in basis.

Another important tax change in 2010 is with Roth IRA conversions.  Using a Roth IRA is a wonderful way to invest.  Although you do not get a tax deduction when you put money into the Roth IRA, it grows tax free, and you can take it out tax free.  You do not have to start taking distributions at age 70 ½.  You can leave part or all of it to children or grandchildren, who can take it out over their entire life, totally tax free!  The law has not allowed Roth IRAs for single persons earning more than $110,000 a year or married couples earning more than $160,000 a year.  However, in 2010, regardless of large income, a person may be able to convert a traditional IRA, 401(k) plan, profit sharing plan, 403(b) plan, 457 plan or even an inherited 401(k) into a Roth IRA.  Income tax must be paid on the conversion, and it could be a huge tax, but thereafter the Roth IRA and its profits are tax free forever.  It is possible to set up a Roth IRA to invest in real estate, private corporations and LLC’s, etc. and there are techniques for legally reducing the taxes payable upon conversion.

© OKURA & ASSOCIATES, 2010

Happy New Year!  For those of you who had a difficult time in 2009, I sincerely hope that 2010 will be a better year for you.  Here is a 2010 update on important numbers used in Estate Planning and Medicaid Planning.

How much money and property can a person have at death without paying estate taxes? For someone who dies in 2010, everything is tax-free!  There is no federal estate tax this year.  But from 2011, only $1,000,000 is tax-free.  Congress will probably change the estate tax law again in 2010.  I will inform you in this column of changes.

How much can a person give away without paying a gift tax? Effective January 1, 2009, you can give $13,000 each year to each person without having to report it to the IRS.  (The amount is still $13,000 in 2010.)  You can give any amount to a husband or wife who is a U.S. citizen without reporting to the IRS.  If you give more than $13,000 in 2010 to any person in one year, then the amount over $13,000 is a “taxable gift.”  You have to file a gift tax return to report the gift, but you can give up to $1,000,000 of taxable gifts in your lifetime without paying a gift tax.  However, if you give assets away, there will probably be a Medicaid penalty if you need nursing home care.  Do not give away assets (not even your home) without expert advice about the effect of both gift tax laws and Medicaid laws.

How much in assets can a husband and wife have and still qualify for Medicaid to pay nursing home costs for one of them? Effective January 1, 2009, a husband and wife together can have $111,560 in assets and still have Medicaid pay for the nursing home costs for one of them.  (The amount in 2010 is still $111,560.)  This $111,560 is in addition to the following exempt assets, which the government will not count: necessities such as clothing, furniture and appliances; motor vehicles; funeral or burial plans; one burial plot for each family member; one wedding ring and one engagement ring, and up to $750,000 of equity in a home.

If a person is not married, or if both husband and wife need nursing home help, how much in assets can each have and still qualify for Medicaid for nursing home costs? A single person can have $2,000; a married couple can have $4,000.

If you give away assets to your children, how long do you have to wait before you can qualify for Medicaid for nursing home costs without a penalty? The answer is 5 years.  (It is 3 years for transfers to individuals made before February 8, 2006.)  However, this does not mean that you have to wait 5 years before getting Medicaid help.  There are ways to reduce or eliminate the penalty period.

If a person qualifies for Medicaid for nursing home costs, how much of the family income can the spouse keep? The spouse who is not in the nursing home (“community spouse”) can keep all of his or her own income (social security checks, pension checks, etc.).  If the income of the community spouse is less than $2,739 per month, the community spouse can also be given some of the income of the one in the nursing home to bring the community spouse’s income up to $2,739.  (This figure was $2,739 in 2009 as well.)  The one who is in the nursing home has to use the rest of his or her income towards nursing home costs, except for $50 a month, which can be kept.

When is a probate necessary? Probate is necessary if a person dies with real estate of any value in his name only or as a tenant in common.  With assets other than real estate, probate is necessary if a person dies with assets worth over $100,000 which are not in a revocable living trust or joint account, and do not name a beneficiary.

© OKURA & ASSOCIATES, 2010

            Most married couples in Hawaii buy their home as “tenants by the entirety.”  Many have transferred their home to their trusts.  Which is better?  To own your home as tenants by the entirety, or to put your home into your trusts?  Let’s look at the advantages and disadvantages.

            First, I apologize to those of you who are unmarried, divorced or a widow or widower.  “Tenancy by the entirety” can only be used by a married couple.  Read the most recent deed for your property.  See if you own the property as “tenants by the entirety.”  It is also possible to own real estate, savings accounts, stocks and bonds as tenants by the entirety.

            With tenancy by the entirety, if one dies, the property goes to the surviving spouse without going to court for probate.  One spouse cannot sell any part of the property without the signature of the other spouse.  The main advantage of tenancy by the entirety is asset protection from lawsuits.  If somebody sues either the husband or the wife and wins the lawsuit, the person suing cannot touch the property.  To take away the property, the person suing would have to win a lawsuit against both husband and wife.

            When husband and wife put their home into their trusts, they lose the tenancy by the entirety protection.  If one of them gets sued, the person suing could go after the half of the property that is in the trust of the spouse being sued.  Only $30,000 of the value of one property is protected if the person being sued is the head of a family or 65 years of age or older.  For others, only $20,000 of the value of one property is protected.  With tenancy by the entirety, 100% of the property is protected.

            If you are married and have trusts should you put your property into the trusts, or keep owning it as tenants by the entirety?  If you put it in the trusts, you will not have to worry about probate if you die, but a person who sues you could go after the property.  If you keep the property out of the trusts, and own it as tenants by the entirety, it is protected from lawsuits.  However, if both husband and wife die together in an accident, then there will have to be two probates.  If one dies, the property will go to the survivor without probate.  The survivor should then put the property into her trust before she dies. 

            If the husband and wife have A-B trusts and own enough assets to be taxed by the estate tax, then owning the property as tenants by the entirety could cause a problem.  When one dies, and the property goes to the surviving spouse, she has more assets and therefore a greater chance for an estate tax problem when she dies.  This problem can be reduced by having the surviving spouse “disclaim” the half of the property that is supposed to come to her, and cause it to go into the deceased spouse’s trust.  However, disclaiming real estate requires going through probate.

            So what should you do?  If you are young and healthy and not worried about being sued, put your property into your trusts.  If you are worried about being sued, either get a high level of insurance coverage, or keep your property as tenants by the entirety, or both.  If you are elderly and your assets will never be subject to the estate tax, then consider taking your home out of your trust, give it to your children, but keep a life estate as tenants by the entirety.  (A “life estate” means you own your home for the rest of your life.)  That way you don’t have to worry about probate, lawsuits, or nursing home costs.  A single person can also give away the home but keep a life estate, to protect it from probate and nursing home costs. 

 © OKURA & ASSOCIATES, 2009

            According to the Deficit Reduction Act, some important parts of the new law were to be effective from February 8, 2006.  However, the Medicaid program is a joint federal and state program.  The State of Hawaii needed to amend its Medicaid rules found in the Hawaii Administrative Rules.  We kept waiting for the new rules, but Hawaii was very slow in adopting them.  In the July 2009 Estate Planning Insights column I announced that the new rules were coming up for public hearing on July 28, 2009.  Finally, I can inform you that the new Hawaii Medicaid rules became official on October 18, 2009. 

            The delay in the new rules was a blessing for many of our clients.  During the last 3 ½ years, our law firm was able to help many clients legally transfer assets to loved ones, and then qualify for Medicaid for nursing home costs.  Probably all of them would have lost much more of their assets to nursing home costs if the new rules had been in effect.  You can read about some of the important changes in the law in the July 2009 Estate Planning Insights column, a copy of which is in my July 2009 blog at www.okuralaw.com.  You can read the actual new rules in my blog entitled “Notice of Public Hearing and DHS Proposed Rule Change.”    

            There are two important things you must understand as a result of the new rules.  The first is that in order to protect assets from nursing home costs, you must take action more than five years before you enter a nursing home. In the past, you could give away $100,000, and then qualify for Medicaid for nursing home costs 13 months later.  Now, when you give away assets, if you apply for Medicaid for nursing home costs any time within 5 years, there will be a penalty.  The penalty is a period of time during which Medicaid will not pay for your nursing home costs.  In order to avoid a penalty, plan on transferring assets at least 5 years before you need to enter a nursing home. 

            The second important thing is this:  do not turn in an application for Medicaid for nursing home costs until you have consulted with a Medicaid Planning specialist.  Let me show you why.  Suppose mother transfers ownership of her home to her son.  The house and lot are worth $600,000.  A little more than 5 years later, mother, who has less than $2,000 of assets, enters a nursing home and applies for Medicaid.  Son gets to keep the home, and Medicaid pays for Mother’s nursing home costs. 

            Suppose, instead, that after transferring the home to her son, Mother applies for Medicaid one day before 5 years have gone by.  There will be a penalty of more than 5 years and 7 months.  Under the new rules, the penalty period begins not when Mother transferred the home to her son, but when she applies for Medicaid.  Although she has already waited almost 5 years after transferring the home to her son, now she must wait another 5 years and 7 months, a total of 10 years and 7 months before Medicaid will help her!  It is important to know what to transfer, when to transfer, to whom to transfer, how to transfer, when to apply for Medicaid, and when not to apply.  There are so many ways to make a mistake that it is best to consult with a Medicaid Planning attorney before turning in the Medicaid application.    

© OKURA & ASSOCIATES, 2009

ESTATE PLANNING ATTORNEYS

For example, suppose you bought a vacant lot many years ago for $10,000.  Now, that same land is worth $110,000.  If you sell that land for $110,000, your gain is $100,000 ($110,000 minus $10,000).  You have to pay capital gains taxes on that gain.  The federal capital gains tax rate for property held more than one year is generally 15%.  The State of Hawaii rate is 7.25%.  You would have to pay $22,250 in taxes.  (If you itemize deductions, you can take a deduction the following year on your federal income tax return for the state taxes paid.)

Instead of selling that land, suppose you give it to your son.  Your son’s tax basis in the land is $10,000.  When he sells that land for $110,000, he will have to pay the capital gains tax of $22,250.

Now, here is the tax planning opportunity.  Suppose after you bought that land for $10,000, you did not sell it and you did not give it to your son.  Instead, you hold on to the land until you die.  Your son inherits the land from you.  Then he sells it for $110,000.  He does not have to pay any capital gains taxes at all!  When you die owning that land, the tax basis in that land changes or “steps up” from $10,000 to $110,000 (the fair market value on the date of death.)  It is as if your son bought the property from you for $110,000.  When he sells it for $110,000, his gain is zero ($110,000 sale price minus $110,000 tax basis equals zero).  Therefore, his tax is zero.  Your son saves $22,250 in taxes by inheriting property from you instead of getting it from you while you are still alive.

This stepped up basis rule also applies to stocks, your home, and rental property.  (With rental property, the tax basis goes down every year as you depreciate the property.)  It does not apply to annuities or IRAs.  Here is another exception.  If you give property to someone, and that person dies within one year, and you or your spouse inherits that same property from that person, then you do not get a stepped up basis.

One of the best ways to get a stepped up basis for your home is to give it to your children, but keep a “life estate.”  You have given the home away, and protected it from nursing home costs, but you have the right to live there for the rest of your life.  When you die, because you kept the right to live there, the property gets a stepped up basis.  Your children could then sell it for the date of death value without paying any taxes.  (However, there is no stepped up basis if a person dies with a life estate in the year 2010.)  Our law firm has developed other techniques for getting a stepped up basis in other kinds of property such as rental property and stocks.

In 2009, a person can die with up to $3.5 million without paying any death taxes.  For many people, death taxes are no longer a problem.  We need to be paying more attention to capital gains taxes which our children or other loved ones may have to pay if they sell property we give to them.  Before you give away any real estate or stocks that have gone up or down in value, check with an estate planning specialist as to how the tax basis rules will affect your gift.

© OKURA & ASSOCIATES, 2009