Articles Posted in Taxes

AN APPRAISAL IS NEEDED UPON DEATH OF A PROPERTY OWNER.  A routine part of trust administration or probate administration is to obtain an appraisal of each property owned.  This is for income tax reasons.  Because the income tax basis is increased “stepped up” upon death to fair market value an appraisal is needed to prove the exact date of death value.  A licensed appraiser is needed to do this.  A realtor’s letter of value opinion is not sufficient.  There are licensed residential appraisers and licensed commercial property appraisers.  Aside from tax purposes, an appraisal is also useful to determine actual value to help to deciding what to do with a property.

INCOME TAX “BASIS” CONCEPT. Under our system of federal and state income tax, if the property is sold before death for more than what was pay for it then there is a capital gain. There are special rates which apply to capital gains depending  upon one’s tax bracket. To compute capital gains, you subtract the income tax basis of the property from the net selling price. The income tax “basis” is what was paid for the property in the first place minus any depreciation and adding any expenditures for capital improvements.

DEATH AFFECTS THE BASIS. The basis of property acquired from a deceased person’s probate estate or trust is generally it’s “fair market value” on the date of the decedent’s death. Thus, the children who inherit a property from their parents through a trust or through a probate proceeding will have a date of death income tax basis. This is known as the step-up in basis at death. An appraisal is necessary to legally prove the date of death value.

SORT OUT WHAT NEEDS TO BE FILED.  A routine part of trust administration or probate administration is for the Probate Executor or the Successor Trustee of a living trust to sort out the income tax situation.  First, you have to determine if the individual income tax return filings of the deceased are up to date.  Individual tax returns, form 1040 federal and form 540 state are due each April 15 for the previous year.  Thus, 2016 returns were due on April 15, 2017 and so on.  It is the responsibility of the Executor or Successor Trustee to make sure the proper returns are filed.

INDIVIDUAL RETURNS FOR THE YEAR OF DEATH.   Individual income tax returns are due for the year in which a person dies, even if they do not live until the end of the year.  Thus, if a person dies on October 10, 2016 for example, the normal individual returns for 2016 would have been due April 15, 2017.  The due date can be extended 6 months by filing extension request forms by April 15.  The returns filed should check the box “final return” and state the date of death of the deceased.  If you forget to check the box of it being a final return, then the IRS will keep sending you letters in later years asking for returns to be filed.

FIDUCIARY RETURNS FOR THE YEAR OF DEATH.   In addition to the individual tax returns, fiduciary income tax returns, forms 1041 federal and 541 for the state are due if the estate or trust has income received after the death of the person involved.  (If the income is below the filing limit for that year the fiduciary returns may not be due but there may be reasons to file them anyway so the trust has a complete filing history.)  Thus, in the above example of a person who died on October 10, 2016, there would need to be fiduciary tax returns filed to report the income received from October 10 until December 31, 2016.  Those returns would be due April 15, 2017 but can be extended 5 months until September 15 if extension application forms are filed by April 15.  This situation typically occurs where the trust or estate has income earning assets such as bank accounts or stock market accounts or rental properties.



Can we avoid paying debts?If a person passes away leaving money or property there may need to be a probate court administration of the estate. If there is a living trust and all of the deceased person’s assets have been placed into the living trust prior to death, there is no need for a probate court administration and the procedures discussed in this article would not be applicable to a living trust situation. The point of a probate court administration is to get somebody appointed as the administrator or executor of the estate (also known as the personal representative) who has authority of the court to handle the money and property and accounts of the deceased person. The personal representative is also responsible for paying the debts and taxes before the estate is distributed out to the heirs.


Probate Debts & Taxes – Persons or companies who are owed money by the deceased person are known as creditors. Creditors include those with contract claims, tort claims (as an accident claim for example), or otherwise.  They California and local government agencies including the franchise tax board are generally subject to the same creditor claims and notification rules.  However, taxes owing to the federal government are covered by federal law.


NOTIFICATION TO CREDITORSThe personal representative is required to notify the creditors so that the time limit for filing their claims with the probate estate starts to run. The initial notification to creditors is the publication of the notice of petition to administer estate in the local newspaper which is done as part of the procedure of filing the probate case with the probate court. The personal representative does need to send out a notice to “all known and reasonably ascertainable creditors” in the mail.  The court published form used for this notification contains a warning to creditors to file their claims within the applicable time limits which are the last to occur of the following dates: four months after the date the personal representative is appointed by the court or 60 days after the date the notice to creditors was mailed. It is incumbent upon the personal representative to notify every conceivable claimant so that these time deadlines begin to run because the estate cannot be closed and distributions cannot be made until these time periods have run.  The special limitations on creditors claims are designed to speed up the administration of a probate estate. Without these certain time periods, creditors would be allowed to file lawsuits far into the future. Typically, a claim on a written agreement or account which is unpaid can be sued on up to four years from the date of payment is due. The creditors claim rules supersede the 4 year limit.



Retired couples typically have choices about how to pass on the family home. Might they make a mistake and give away the house too soon? They could sell the home and put the cash in the bank and rent. Another way people sometimes handle this is to draw up and record a deed transferring a home now to their children. The logic is that the children are going to get the house anyway so why not just given to them now. The third choice is to continue ownership of the house until both husband and wife have passed away and transfer the house to the children through their will or better yet through their living trust.

ight they make a mistake and give away the house too soon?


  1. Sell now. However, if they make more than $500,000 gain on the sale of the house there will be income tax to pay. Also, they would still have to have a place to live which would cost rent and use up part of the gain on the sale. Moreover, selling the house at the present time would give up future appreciation.
  2. Give it up now. By giving the house to the children at the present time, the couple could still live in the house by making arrangements with the children. However, the income tax basis of the couple would carry over to the children since under the tax laws this is a gift during lifetime. The income tax basis is what the couple paid for the house plus the cost of any documented improvements. When the couple have passed away, the children could sell the house but most likely would have capital gains if the house has gone up in value over what the couple paid. For example, assume the couple paid $200,000 to purchase the house in 1990 and spent 30,000 on remodel costs. That would make their tax basis $230,000. Now supposing the children sell the house in 2016 after their parents are gone and at that time the house is worth $800,000.  The children would have reportable capital gains of the difference between $800,000 and $230,000 which is $570,000. Assuming a federal and state tax rate of about 33% combined, there would be about $180,000 tax to be paid. The only way the children could get out of paying most of the tax would be for the children to move into the house, claim it  as their personal residence, and utilize the $500,000 exclusion from available to married couples.

Can I Really Spend All My Inheritance Money, or Does Uncle Same Get a Portion?


taxableIs My Inheritance Taxable – Your inheritance of money or property may come from the estate of a deceased person or from a trust established previously.  These types of things are generally referred to as “bequests” or “gifts” as far as tax law is concerned.  People receiving bequests or gifts are referred to as “beneficiaries”.


A gift or bequest of a specific sum of money or of specific property, which is required by the specific terms of the will or trust instrument and is properly paid or credited to a beneficiary is not treated as income to the beneficiary. Instead, it is treated as a gift under the tax laws which by definition is not reportable income.


In order for a gift or bequest to be excludable from the taxable income of the recipient, the terms of the will or trust providing for the payment must not provide for payment in more than three installments.  If paid in more than three installments, then complex trust taxation rules apply for determining how much of the payment is income to the recipient.

Image on lovely Orange County residenceSubtitle:  Pull out tax free gain while downsizing


Under our system of federal and state income tax, if your personal residence is sold before death for more than what was paid for it then there is a capital gain. For example, if you purchased your home for $100,000 and sell it for $300,000 there would be a capital gain of $200,000.  The capital gain is reported as income on your personal income tax return.  Figure roughly a combined federal and state tax on the $200,000 gain of 1/3rd which would be $66,666.


An individual may exclude up to $250,000 in gain and a married couple may exclude up the $500,000 on a joint return if the property was the “personal residence”.  A personal residence is defined under the tax law as a residence used as your principal residence for periods aggregating two years (730 days) during the five years leading up to the sale.  Thus, you don’t have to actually have to be living in the residence at the time of the sale if you meet the 2 year test.  Short temporary absences and vacations are counted as part of the 730 days.

Image of family members who run a florist business

Partners pay tax on income earned even if it is not paid out to them

The taxation of Family Limited Partnerships should be carefully considered in advance of setting up and rolling out your new FLP.


State laws have provisions allowing people to establish limited partnerships.  Limited partnerships provide limited liability protection for the limited partners similar to the liability protection afforded corporation shareholders.  The limited partnership is established by filing a form in the state in which it is being established and by the preparation of a limited partnership agreement which governs the ownership income and management of the partnership. The limited partnership agreement is custom prepared by the attorney forming the limited partnership and can have many variable aspects that need to be considered as part of the formation process.

A family limited partnership is legally no different from any other limited partnership except that it’s only members are family members. The term “family limited partnership” is something commonly used in the estate planning and asset protection field. A family limited partnership will have one or more general partners and one or more limited partners. Their respective roles are defined in the chart below:


Partner type What they do
♦ General Partners Manage and control all of the money, business and affairs of the partnership.   They sign all checks and all contracts that the partnership enters into.
♦ Limited Partners Limited partners have no voice in the management and no control.  They only have voting rights to vote on specific things such as sale of property or removal of the General Partner


The Internal Revenue Code, which is the place where all of the federal tax laws are located in the federal legal system, has provisions for partnerships.  There is no distinction in the tax laws between prayer partnerships, limited partnerships, and family limited partnerships. Any partnership is a separate legal entity and would need to obtain a federal tax ID# upon formation.   Tax returns to be filed are the form 1065 income tax return and California  partnership tax return form 565. These tax returns are due on April 15.


The partnership does not actually pay any income taxes. The partnership tax returns merely report the income for the total partnership enterprise. The partners are identified in the partnership income tax returns and the percentages of ownership of assets and income are stated.  The partnership income is then allocated to each partner according to his or her percentage.  The partnership income tax returns have a form K-1 for each partner stating that partner’s share of the partnership income, deductions and credits.  Each partner then takes the form K-1 to his or her tax return preparer and the amounts on the form K-1 are reported on the the partners’ personal income tax returns.  A partnership is often referred to in tax literature as a “pass through entity” meaning that all partnership income is not taxed at the partnership level but simply passes through and is tax to the partners on their individual income tax returns.

CALL  (949) 229-7034  to speak with Lawyer  David L. Crockett


Without exception the partnership income earned by the partnership is allocated to the partners whether or not they actually receiving income.  In the context of a family limited partnership this can create problems if some of the income is held back and not distributed. This may occur for example in a situation where the general partners have discretion to not pay out all the income which is a typical asset protection clause. However, even if the income is not actually paid out to the partners, they still have to pay the taxes on the income. Therefore, general partners will typically try to get enough cash out to the limited partners so that they can pay their taxes by April 15.

Purposes of Family Limited Partnerships

Image of umbrella over house, care and stack of coinsPeople form family limited partnerships (FLP’s) to (i) transfer ownership of properties or assets to family members while still maintaining control; (ii) to save on estate and gift taxes; (iv) to shift income from parents’ higher tax brackets to children’s lower tax brackets; (iii) to provide some asset protection against liabilities of the property or assets put into the limited partnership or (iv) to provide asset protection against creditors of the limited partners.

Typical example-an apartment building

A mom and dad own a 10 unit apartment building which is paid for and provides substantial cash flow income.  They have 3 children and 1 of the children is heavily in debt and cannot handle money.  They transfer the apartments into a FLP and the FLP agreement provides that the parents own 40% of the assets and income and the children own 60%.  It is set up so that payment of income is discretionary with the parents who are the general partners.  The FLP prevents any creditors of the building from going after the parents’ or the childrens’ individual assets outside of the FLP.

The FLP prevents any of the childrens’ creditors from forcing a payment of income to pay the children’s debts.  The parents essentially still control the money flow and manage the property. There are many variations possible to this so the entire financial and legal picture needs to be gone into before jumping into any FLP.

Legal status

A Limited Partnership is a legally recognized type of partnership entity that has one or more general partners and one or more limited partners.  The designation as a “family” limited partnership simply means that family members are the owners.  It maintains its own bank accounts and accounting records, its own tax id# and files its own tax returns, including partnership forms: IRS form 1065 and California FTB form 565.


A legal contract known as a limited partnership agreement is prepared and signed by all the partners and there are also registration forms which must be filed with the state.  After that, various transfer documents are done to place property and assets into the FLP.

The role of the partner types

Partner type What they do
♦ General Partners Manage and control all of the money, business and affairs of the partnership.   They sign all checks and all contracts that the partnership enters into.
♦ Limited Partners Limited partners have no voice in the management and no control.  They only have voting rights to vote on specific things such as sale of property or removal of the General Partner

Limited liability and asset protection for limited partners

The law governing  limited partnerships (including  family limited partnerships) provides that the limited partners do not have individual liability for debts and claims against the partnership.  The most that a limited partner can lose is his or her investment in the limited partnership.  In addition, a limited partner has asset protection, depending upon how the FLP agreement is prepared, where the general partner retains discretion to decide if income is to be paid out the limited partners.

Unlimited liability for general partners

The general partners are personally liable for the debts and obligations of the limited partnership.  A solution to this in some situations is to form a corporation and have the corporation serve as the general partner.  The corporation could be a California corporation or it could be a corporation formed in another state or country for more confidentiality and more asset protection.


A limited partnership is a permanent legal contract between the general partners and the limited partners.  It therefore cannot be changed or revoked unless all of the limited partners and general partners agree in writing to do so.  Property and money cannot be removed or paid out unless everyone agrees.  Contrast this with living trust arrangements where properties can be freely taken in and out of a living trust and percentages of what various beneficiaries will receive can be changed solely by the parents.

Planning and formation issues

In preparing the limited partnership agreement, there are many custom variables and options which the estate attorney forming it should consider including: (i) how long will the FLP last; (ii) what happens on the death, divorce or disability of a partner; (iii) what will the limited partners be permitted to vote on; (iv) should the general partner be an individual or a corporation; (v) how frequently will money and profits be paid out to the partners and can some money be held back for reserves; (vi) will there be any requirement for partners to put more money into the partnership; (vii) what will the percentages of ownership of capital and profits/losses be among the partners; (viii) what property and assets will go into the FLP and (ix) will there be some asset provision protections built in.

CALL  (949) 229-7034  to speak with Lawyer  David L. Crockett

Taxation considerations

FLP’s once formed are permanent and eliminate some tax flexibility such as individual partners being able to sell their shares or being able to do a tax deferred exchange of their share.  For example, if the family mentioned in the example above decided to not do a FLP and instead decided to hold ownership to the apartment building as tenants in common, there is nothing in the tax law preventing any owner from selling their share or doing a tax-deferred exchange with their share.  On the other hand, owning as tenants in common eliminates asset protection and leaves all owners open to liabilities of the apartment building and of their own personal liabilities.  Also, there are estate and gift tax considerations which must be understood and discussed before putting any assets into a family limited partnership. There may be a loss of basis step up which would otherwise occur on the death of a partner as one example.

Taxation of Irrevocable Trusts – Tax rates can be high on permanent trusts


Image of older man holding his cat while sitting on benchThe term “irrevocable trust” is commonly used by estate lawyers and financial planners to describe a trust which is permanent and cannot be changed or revoked. 

An example would be where you establish a trust and put $100,000 into it for the benefit of your children and the $100,000 stays there no matter what happens to you.  The actual documentation establishing the trust has to be read before you can say for sure if the trust is permanent or irrevocable.


The Internal Revenue Code, which is the place where all of the federal tax laws are located in the federal legal system, has provisions for the taxation of permanent/irrevocable trusts.  A permanent/irrevocable trust is a separate taxable entity and would need to obtain a federal tax ID# upon formation.   Tax returns to be filed are form 1041 fiduciary income tax return and California fiduciary income tax return form 541. These tax returns are due on April 15.  

Living Trust Taxation – The IRS ignores revocable living trusts


Image of Old man resting on bench and cuddling dog and catThe term “living trust” is commonly used by estate lawyers and financial planners to describe a trust which is established during a person’s lifetime and which is revocable and changeable. 

Living trusts – are also known as “revocable trusts”. A living trust could have components which are permanent and not revocable so the actual documentation establishing the trust has to be read before you can say for sure if the trust is revocable.


Documentation prepared to establish a trust is not registered with any government agency or taxing authority. The only way to find out what a trust says is to actually have the documentation prepared and signed when the trust was formed. Typically the estate lawyer will retain a copy of any trust prepared and then the people establishing the trust will have their own copies. However, in the context of probate and estates, we have seen instances where the trust documentation is lost or destroyed so nobody can figure out what the trust requires. That is the subject of another blog.


The Internal Revenue Code, which is the place where all of the federal tax laws are located in the federal legal system, has a special term for revocable trusts.  That term is “grantor trust”.  Under the grantor trust rules the person who transfers property to a trust and retains certain powers or interests is treated as the owner of what is transferred to the trust for income tax purposes. This means for example if you transfer a savings account to a revocable trust, the interest income on that savings account is reported on your personal tax return. The IRS does not recognize revocable trusts (grantor trusts) as a tax paying entity. The IRS does not require revocable trusts (grantor trusts) to have a separate tax ID number. In fact, if it is a revocable trust, your Social Security number would be the number on the account in this situation.