Ask Liz Weston

Get smart with your money

Taxes

Q&A: Don’t keep a mortgage just for the tax deduction

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Dear Liz: Does the new tax law, with its increased standard deduction, change the calculus of maintaining my mortgage? I owe about $250,000 at 3.25% on a 30-year mortgage. I no longer itemize, so I don’t get the benefit of the tax deduction for the interest. My payments are about $1,500 a month, but I could easily pay it off.

Answer: It never made much sense to keep a mortgage just for the tax deduction. The tax savings offset only a portion of the interest you pay. (If you’re in a 33% combined state and federal tax bracket, for example, you’d get at most 33 cents back for every $1 in mortgage interest you paid.)

A more compelling reason to keep a mortgage would be if you were able to get a better return on your money by investing it, or if you didn’t want to have a big chunk of your wealth tied up in a single, illiquid asset.

Q&A: Unloading a timeshare

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Dear Liz: How can a timeshare owner get rid of the timeshare and claim the loss on taxes?

Answer: Timeshares typically are considered a personal asset, like a boat or a car, so the losses aren’t deductible. The best way out of a timeshare is often to give it back to the developer, if the developer will take it. You also could try to sell it on sites such as RedWeek and Timeshare Users Group. Unless your timeshare is at a high-end property, you are unlikely to recoup much and may have to pay the buyer’s maintenance fees for a year or two as an incentive.

Q&A: Escaping California’s tax auditors is tough even after leaving the state

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Dear Liz: My husband and I will be trying out several different areas after the sale of our Los Angeles area house, which will be some time this summer. What happens if we end up renting in three different states? I’m under the impression that we need to be able to prove that we resided in a particular state for six months and one day in order to say we are residents of that state. Even though my husband has been retired for many years, he still does a small amount of business through a company based in Southern California. Will we be forced to pay California tax even though we are residing elsewhere?

Answer: California, like other higher-tax states, has residency auditors whose specialty is asserting that affluent people who have left the state are still legal residents and thus are subject to its taxes. The audits can be stunningly thorough, looking at everything from the doctors you visit to where your artwork and other valuable possessions are stored.

If audited, you would need to prove that you have a fixed, permanent residence elsewhere and that it’s truly your home. And yes, it’s up to the taxpayer to prove this — there’s no presumption of innocence in tax audits, says tax attorney Mark Klein, chairman of Hodgson Russ LLP in New York City. (New York is another state with notoriously hard-nosed residency auditors.)

Just leaving the state for six months and registering to vote elsewhere typically won’t be enough. You likely would need to spend substantially more time in your new “home” state than in California. Klein, who recently taught a session on establishing residency at the AICPA’s annual ENGAGE conference, tells his clients to spend at least two months in the new place for every month they spend in the old one.

Also, you should “stick the landing,” in Klein’s words. Let’s say you try to establish residency in Nevada but then move to Florida by the time California’s auditors find you. They may well decide that your Nevada stay was temporary and that you were still subject to California taxes during the time you lived in the Silver State.

Escaping the long arm of California’s tax auditors could be tough while you’re still figuring out where to live next. You’d be smart to consult a CPA experienced with California residency audits for advice on how to cut ties to the state cleanly.

Q&A: Estate tax versus inheritance tax

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Dear Liz: In a recent column, you wrote that “only six states … have inheritance taxes.” My state of Oregon is not listed. Oregon certainly has an estate tax (one of the highest in the U.S.) and Washington also has one.

Answer: Many people confuse estate and inheritance taxes, but they’re not the same thing.

As the name implies, estate taxes are taxes levied on the dead person’s estate. The federal government, 12 states (Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont and Washington) and the District of Columbia have estate taxes.

Only the six states mentioned in the previous column — Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania — have an inheritance tax, which is levied on the person who inherits. New Jersey had an estate tax, but that was repealed in 2018, leaving Maryland as the only state with both types of tax.

Q&A: Selling an inherited house to a relative will affect tax treatment

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Dear Liz: My mother recently died, leaving a house to my three siblings and me. We had the house appraised in February. My sister is buying the rest of us out. We decided to give our sister a break and sold her the house below the appraised amount. As the “selling price” (which will be a public record) will be below the appraisal, can I take my “loss” on my taxes this year? I gave her a $25,000 reduction, so I assume I can take $3,000 a year for eight years. Is this true?

Answer: Probably not.

The sale to a family member probably dooms any chance of taking a capital loss, said Mark Luscombe, principal analyst for tax and accounting at Wolters Kluwer.

“The law is not entirely clear on this topic with the IRS perhaps taking a more severe stand than the Tax Court, but both seem to frown on any use of the real estate for personal purposes after the death of the parent,” Luscombe said.

For a capital loss, the IRS appears to require that the inherited property be sold in an arm’s length transaction to an unrelated person, Luscombe said. The IRS also requires that you and your siblings did not use the property for personal purposes and did not intend to convert the property to personal use before the sale.

Even the Tax Court cases appear to at least require a conversion to an income-producing purpose before the sale and no personal use of the property after the death of the parent.

“The reader may find a court willing to say that personal use by a sibling is not personal use by the reader, and, from the reader’s perspective, it was converted to investment property,” Luscombe said. “However, since this was a sale to a sibling and not an unrelated person, I think that the IRS would disagree with that position.”

Q&A: Consult a pro when planning elder care

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Dear Liz: My parents and I are discussing the best ways to protect their assets if one of them must live in a nursing home. Their home is paid off, and we were wondering if adding my name on the deed will secure the home from a mandatory sale for caregiving expenses. Please note, I am the only child. Also, I may want to live there someday to care for the other parent. Looking for the best options for saving money and avoiding inheritance tax for this asset.

Answer: Please consult an elder law attorney before you take any steps to “protect” assets because the wrong moves could come back to haunt you (and your parents).

It sounds like you’re contemplating the possibility that one of your parents may wind up on Medicaid, the government health program for the poor that covers nursing home costs. Medicaid has a very low asset limit and uses a “look back” period to discourage people from transferring money or property just so they can qualify. In most states, transfers made within 60 months of the application are examined and, if found to be in violation of the rules, used to determine a penalty period to prevent someone from qualifying for Medicaid coverage. In California, the look-back period is 30 months.

The state can attempt to recoup Medicaid costs from people’s estates by putting liens against their homes. You might see that as an “inheritance tax,” but inheritance taxes are taxes imposed in a few states on people who inherit money or property. Although all states try to recoup Medicaid costs, only six — Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania — have inheritance taxes, and these either exempt or give favorable rates to children who inherit.

Having your name added to the deed can cause problems, as well. Your creditors could go after the home if you’re sued, and you could lose a portion of the step up in tax basis you would get if you inherited the house instead. If you’re married and get divorced, your portion of your parents’ home could be considered a “marital asset” that has to be divided.

It’s great that you and your parents are trying to plan for long-term care, but you should seek out professional guidance.