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Estate Planning: Why It’s Important

A couple of weeks ago, I defended the practice of estate planning. This week, we get into the nuts and bolts. Why run a series on estate planning in a real estate column? The answer is because the bulk of most estates of any size are real property.

As we have defined before, real property is land and that which is permanently attached to it. Other possessions are personal property. Cars, jewelry, furniture and the like are personal property. Houses, barns, commercial buildings and brick outhouses are real property. A mobile home with vinyl skirting is personal property, but one on a brick and concrete foundation is real property. Stocks, bonds and bank accounts are financial assets.

All these taken together, minus any outstanding debts and obligations, constitute an estate. This is what is left to our heirs at our demise, kicking the bucket, sloughing off our mortal coil or insert your own phrase here.

During the lifetime spent working, acquiring and building the estate, taxes are paid every step of the way. Sales taxes, property taxes, income taxes, excise taxes, use taxes, road taxes…the list goes on and on.

Then at the end of life, some folks with time to think about such things try to apply the Concept of Transfer Taxes. This is the idea that the state has the right to tax the transfer of wealth from one generation to another. Notice the term “generation”, the concept doesn’t apply to a surviving spouse, but it does apply to the offspring.

For a simple example, let’s say that Luther owns Luther’s Hardware and Rubber Ducky Emporium. He gets hit by a meteorite and leaves everything to his wife Clydette. We aren’t jumping generations, so the concept doesn’t apply. Remember, we aren’t talking about actual law yet, just the idea behind the stupid law. So even if Clydette is young enough to be Luther’s daughter, no transfer tax.

Now, let’s say that Luther and Clydette both have a tragic Mahjongg accident and give up the ghosts. The transfer proponents say that the government has a right to a portion of the combined estate of Luther and Clydette. Why? Because it’s “fair”. So, if the store is left to their niece Lutherette, Uncle Sam gets a cut. How big? What’s fair?

The newly rich Lutherette has a building worth, if she sold it, $500,000. The stock, if sold for retail, is worth $200,000. The business after expenses and TAXES nets $80,000 a year. The family home is worth $250,000 and the person property Lutherette inherited is worth, if it were sold, about $75,000. The estate also contains $45,000 in financial assets. In total, Lutherette has inherited an estate theoretically worth $ 1,150,000.

Let’s say that the tax is 30%. What does the tax apply to? The entire estate? The business and financial assets and the real property? What’s fair? It is a million dollar estate, but she only received $45,000 in financial assets. If the tax only applies to the portion over one million dollars, she still has to come out of pocket for $5000 to pay the tax. If the tax applies to the business, she will have a tax bill of $260,000. She will have to sell the house just to pay the tax.

I know, there are exclusions and what not; after all, the government wants to be fair. Just remember the Concept of Transfer Taxes; what’s yours is yours and your spouse’s, but your kids get what is left over after the government gets what’s fair.

For questions, email: LawyerBuddy@MudPuddleRealEstate.com.