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:

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.

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.