Get smart with your money
By Liz Weston
Dear Liz: Where can I sign up to have my name removed from the mailing lists for credit card offers?
Answer: You can remove yourself from marketing lists provided by credit bureaus to credit card and insurance companies by calling (888) 5-OPT-OUT (567-8688) or visiting www.optoutprescreen.com. You should see a significant reduction over time in the offers you receive, although you may still get unsolicited offers from other sources.
By Liz Weston
Dear Liz: My husband and I have given our daughters gifts over the years, but we have never exceeded the $26,000 gift tax limit for a married couple. Do we need to file IRS Form 709 to split the gifts? If so, how to do we file for past years?
Answer: The gift tax system exists to help prevent wealthy people from transferring large amounts to their heirs during the donors’ lifetimes in an attempt to avoid estate taxes. Each person, however, is allowed to give a certain amount each year to any number of recipients.
The current gift tax exemption is $13,000. Each of you could give each of your daughters $13,000 annually. That means the two of you could give the two of them a total of $52,000 a year without having to file a gift tax return. Tuition or medical expenses you pay directly on behalf of another person do not count toward the limit.
The $13,000-per-recipient limit has been in place since Jan. 1, 2009. The limit was $12,000 from 2006 to 2008 and $11,000 from 2002 to 2005.
Only if donors give more than the annual exemption amount are they required to file gift tax returns. Even then, the givers typically don’t owe gift taxes. The lifetime gift tax exemption is currently $5.12 million. In other words, you would have to give away more than $5 million above and beyond the $13,000 per recipient limit to incur a tax. The lifetime limit is scheduled to fall back to $1 million in 2013, but it will still affect relatively few givers. If you did inadvertently exceed the annual limits, you can talk to a tax pro about filing the 709 form.
By Liz Weston
Dear Liz: You recently answered a question about capital gains taxes that stemmed from two siblings selling their parents’ home. The children had been added to the parents’ deed, presumably before the parents’ death. You mentioned that the capital gains tax would have been avoided if the parents had bequeathed the home rather than gifting it during their lifetimes. Presumably bequeathing the home at death would have necessitated probate and incurred inheritance taxes. Are these costs more than offset by the stepped-up tax basis received?
Answer: Your questions illustrate exactly why no parent should add a child (or anyone else) to a home deed without discussing the issue with an estate-planning attorney first. Too often, laypeople misunderstand what’s involved in probate and make expensive mistakes trying to avoid it.
In some states, probate — the court process that typically follows death — is relatively swift and not very expensive. Trying to avoid it isn’t necessarily cost effective. In other states, including California, the process potentially can take many months and eat up a good chunk of an estate. When that’s the case, it can be prudent to take steps during life to sidestep probate at death.
There are often better ways to do so, however, than adding someone to a deed. A living trust, for example, can be a good way to avoid probate and preserve the tax benefits of bequeathing, rather than gifting, assets. Living trusts can vary in cost, but a lawyer can typically set one up for $2,000 or $3,000. If you compare that with the $25,000 or more the siblings will pay in capital gains on a relatively modest home sale, you can see that the living trust probably is a better deal.
Now let’s turn to the issue of estate taxes. If the assets left by the deceased are substantial enough to incur estate taxes, they will do so whether or not the estate goes through probate. Avoiding probate, in other words, does not avoid estate taxes. Currently, only estates worth more than $5.12 million face federal estate taxes. That limit is scheduled to drop next year to $1 million, but will still affect relatively few estates.
By Liz Weston
Dear Liz: Your column on the tax issues that develop when parents deed their property to their children should help educate a lot of people. But sometimes this is done to reduce the parents’ assets so they will be eligible for Medicaid after the expiration of the look-back period. In this case, paying the capital gains tax is appropriate, because they are asking the state to pay potentially very large senior care bills.
Answer: Some would question whether it’s ever appropriate for seniors to deliberately impoverish themselves by transferring away assets in order to qualify for Medicaid, which pays long-term care expenses for the indigent. The “look back” period, in which states examine asset transfers before a Medicaid application, was established to discourage such maneuvers. Once again, it’s smart to get a legal opinion before transferring big assets. An elder-law attorney could weigh in on the pros and cons of Medicaid planning.
By Liz Weston
Dear Liz: My wife and her brother are selling their parents’ home. The parents transferred the deed to their children’s names years ago. My wife should receive about $85,000 from the sale. Our yearly income (one salary; she’s a stay-at-home mom) is around $75,000. My wife is worried about capital gains taxes and wants to reinvest in another real estate property because she’s heard that that will eliminate the capital gains tax. Is that correct? I would really rather invest that money in our current home (finish the basement into a family room, update some items) and pay off our car loan than worry about another property to take care of. What do you think?
Answer: A 1031 exchange is a tax maneuver that allows owners of business or investment property to swap the real estate they have with another property, a transaction that can defer (but not necessarily eliminate) capital gains taxes.
It’s questionable whether your in-laws’ home would qualify as business or investment property, said Mark Luscombe, principal federal tax analyst for tax research firm CCH.
“Were the parents paying rent to the children after the title was passed to the children? If the kids owned the property and the parents were living there without paying rent, I do not think that would constitute investment property,” Luscombe said. “Perhaps if the parents were still paying upkeep expenses and real estate taxes, that might approach the equivalence of rent.”
If there’s a chance the property might qualify, your wife should consult a tax pro experienced with 1031 exchanges for details. Otherwise, she’ll need to write some good-sized checks to the tax authorities. Currently the federal capital gains tax rate is a maximum of 15%, although it will rise to 20% on Jan. 1 if Congress doesn’t reach a compromise on the so-called fiscal cliff. Add to that any state or local taxes on capital gains.
You may think of these taxes as a small price to pay compared with the risk of owning a piece of rental property. Your wife may have another concern that she has not voiced, however: She may not want this legacy from her parents to disappear into the general family budget. She may feel an obligation to preserve and try to grow the money, rather than sinking it into home improvements and other consumption. Legally, gifts and inheritances are considered separate property owned only by the spouse to whom they were given, even in community property states where most other assets are considered jointly owned.
If she wants to keep this money separate, in other words, that’s her right. It would be nice if she carved out a small chunk for family consumption, but she’s under no obligation to do so. If a 1031 exchange isn’t possible or feasible, then she could consult a fee-only planner about other ways to invest the money for the future.
By the way, it needs to be said: This tax bill was avoidable. If your in-laws had, instead of gifting the property, waited and bequeathed it at their deaths, the home would have received a so-called step-up in tax basis. Such a step-up in effect eliminates the need to pay capital gains taxes on any home price appreciation that occurred during the parents’ lives. Any parent thinking of adding a child’s name to a real estate deed should first consult an estate planning attorney to understand the ramifications, since gifting property this way can be an expensive mistake.
By Liz Weston
Dear Liz: I read your response to the person questioning the rationale behind taxpayer-supported federal student loans. Your response was well written, but do you have any information about how much money is owed to the government for student loans and what percentage of all the loans are actually paid back in full? You mentioned that the government can garnish wages and Social Security checks and seize tax refunds, but does the government follow through and hold these people accountable? Does the government have personnel to do this or is this just a threat?
Answer: Millions of unhappy student loan borrowers can assure you the government’s considerable powers to collect defaulted student loans are much more than a threat. In addition to its own collection activities, the U.S. Department of Education also hires a number of private collection agencies to help recoup what’s owed.
As a result, the government collects more than 100 cents on every defaulted dollar once accumulated interest and penalties are included, according to the Education Department’s most recent report. On a net present value basis — when future collections are discounted back to today’s dollars — the government recovers about 80% of the defaulted debt.
Decades ago, it was possible to skip out on federal student loan debt without serious consequences. Public outrage over that fact led to much stronger collection efforts. That has resulted in the federal government recovering about $10 billion in defaulted student loan debt every year, said Mark Kantrowitz, publisher of the FinAid.org and FastWeb financial aid sites.