Bitcoin and Estate Planning

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Being an estate planning geek, I sometimes troll about online to see what people are talking about. Some things are predictable (Should I have a living trust or a will), others are rare (Can I leave the house to the cat?).

From the rare column: Estate Planning and Bitcoin.Of course, bitcoin is an asset and can be bequeathed by will or distributed as part of a trust just like any other asset. Except it isn’t just like any other asset, and presents certain complications, tending to center on three issues: knowledge, access, and taxes.

But in order to understand the complications, you must first understand what bitcoin is. So—Geek Alert: for those just joining us in the digital world: What is bitcoin?

Bitcoin is probably best understood as a decentralized digital currency (I know…that really helps). It is “like” money. Over 100,000 merchants and vendors accept bitcoin as payment, some employees are paid in bitcoin. But the differences are big: Unlike U.S. currency or Euros or Yen, with bitcoin there is no tangible representation of the currency—no notes or coins. Also, there is no central bank or government or other agency. The argument is that this gives it a stability in a chaotic world, but it also means (and this is important to us) that there is no place to “go” to “access the account”, or even to find out about it.

Users of bitcoin engage in direct transactions with each other. Some people hold bitcoin as an investment (as is true for other currencies), and it can be held in an IRA. At the moment this is being written, one bitcoin is equal to $4,840.00 USD (bitcoin is available in smaller increments than the bitcoin itself). The transactions are recoded in a public ledger, which is a distributed database and is called a blockchain. The blockchain is constantly (approximately 6 times per hour) updated across the network. For our purposes, the point is that the only “place” that the bitcoin “exists” is in the blockchain. Which is public (though you need a certain software), but ownership is “pseudonymous”. This means that ownership is not recorded in the owner’s name but tied to a bitcoin address. The bitcoin is accessed by means of two (digital) keys, one public and one private. A user will frequently store the two keys in a digital wallet. A public key is just that, but if the owner losses the private key there is NO way to access the bitcoin, it is essentially gone.

The above explanation is simplistic and ignores some key points. But this is not a bitcoin users-guide, it is about estate planning. And I think it is enough to lay the groundwork for the following:

1. Knowledge: If you own bitcoin, it is essential that your executor/trustee/heirs/somebody knows about the bitcoin. If you choose not to tell them now (and you may), at least leave some documentation that will be found telling of its existence. No bank will mail a statement or a 1099 (there is no bank), they won’t know if you don’t tell them. Frequently the hardest task facing those left behind is “figuring out what is going on” in the absence of clear instructions and documentation from the deceased family member. In the instance of bitcoin, it is virtually impossible without some instruction or guidance from you. (And extra-credit if you spotted the pun.)

2. Access: Even if they do know about your bitcoin, without your private key they can not access your bitcoin. At all. Period. Ever. So it is important that you have arranged some means by which it can be accessed. This is true for a good many digital assets—without usernames, passwords, etc., there is no accessing these things. Most of us don’t like passing around our logon info and private keys, and this is a major issue in Estate Planning that all-too-frequently goes unconsidered. Look for information from us on the handling of digital assets in a later blog post. As a service to our clients, Sorrell Law provides a Digital Asset Management Checklist in all of our complete estate plans.

3. Taxes: You probably knew this was coming: There is a tax issue. The IRS, in their infinite wisdom (actually there were plausible—if not adequate—reasons, but that is for another day), has decided that for US tax purposes bitcoin is property rather than currency (IRS Notice 2014-21). Among other things, this means that when bitcoin is spent by a user, the user must recognize taxable ordinary-or-capital gains (as appropriate) or loss on the difference between her or his basis (usually Fair Market Value, FMV, when acquired) and the FMV of the bitcoin when used. But in addition to this, as with any other asset subject to capital gains, the estate planner must look ahead to the tax impact of planning. Generally, one tries to leave one’s heirs highly appreciated assets (because the step-up in basis will result in tax savings) and spend depreciated assets (so that you can realize the loss, since it will be lost at death). This would be the case with bitcoin and other digital currencies. And so again; planning means that: planning.

If you are concerned about incapacity, you may also want to make sure that the agent under your Durable Power of Attorney has the authority and ability to deal with digital assets, including digital currency. The basic NC statutory forms are inadequate. And if you have a trust (either a living or testamentary trust) that will be potentially holding bitcoin for a long period of time, you may want to consider how your Trustee’s handling of your bitcoin will be impacted by the Prudent Investor Act.

But the main thing is that planning means being prepared. None of us knows which day will be the last day we have to prepare our estate plan—so rule one is don’t procrastinate.

NC Case Law: RP Restraints on Alienation -or- Can Mom Rent the House?

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NC Case Law: Davis v Davis and Restraints on Alienation: -or- Can Mom Rent the House? (NC COA16-400, 11/01/2016)

In Davis v Davis, the Court recently invalidated a deed provision that attempted to restrict the owner’s ability to rent a house, again affirming North Carolina’s commitment to the idea that owning real estate means you own real estate—and you can do with it as you see fit.

Okay…there are a million exceptions to this. But one of them is not renting—attempts to give someone a life estate and then to prevent them from renting the property to someone else will probably not work.

The facts in Davis interesting: Mom and Dad bought a beach house in Dare County. They later decided to gift the property to three of their children* (they had paid off debt for a fourth child) retaining a life estate in the house for themselves. They placed a clumsily-worded restriction in the deed that they signed attempting to restrict use of the house to ONLY Mom and Dad, a fair reading of which would seem to preclude Mom and Dad from renting the property. Testimony from the attorney that drafted the deed confirmed that this was the intent of the provision. Nevertheless, Mom and Dad would, on occasion, rent the beach house for short periods of time to offset the cost of owning the house. When Dad died, the kids lovingly sent their dear Mother a letter communicating their intention to enforce the deed restriction. Mom rented the house anyway, as was the custom while Dad was alive, and her wonderful kids took her to court. Ain’t family great?

One of the issues, and the one we are interested in, is this: Could Mom own a life estate in the house that she could not turn around and rent?

There is a common and widespread misconception about a property owner’s ability to rent the owner’s property. All too often these days, that ability is considered a mere “privilege” (especially by over-zealous POAs). But our law (both NC and US) takes property ownership very seriously, and one of the key “incidents” of ownership is the ability of an owner to sell or rent what she or he owns to another. The ability of a property owner to use the owner’s property as the owner sees fit, including renting its use to someone else, has historically been one of our nation’s most fundamental and legally protected rights. Here, the court said reasonable restrictions in deeds may be enforceable, but noted in passing that “unlimited restraints” are “per se unreasonable” and hence will not be enforced.

This all sorts of implications, but we are concerned with only two here. Number one, as in the case at hand, deed restrictions that purport to “restrict alienation”—meaning that the owner can’t rent the property to another, will usually be unenforceable. Secondly, and related, provisions in a will that purport to devise real estate to an heir with limitations imposed by the will (“I leave the house to Mary so long as she lives in it” or “so long as she does not rent it out”) may well also be unenforceable. The will scenario is a little more complicated. It depends on what the restrictions are and how the provisions are drafted; but a gift of real property to Susan that says Susan can’t rent the property to Dave probably won’t stand. (POAs and Condo Associations are a different matter that we are not discussing here.)

If the Davis’ had formed a trust, conveyed the beach house to the trust, and had a provision in the Trust Agreement prohibiting the rental of the property, that would have worked (had they really wanted to do that) for this purpose, though we don’t know what other purposes they may have had (Medicaid planning anyone?). If you want to control property (such as prohibiting rental) after you pass away, or after you give the property away, trusts are often the way to go. Deed restrictions can work for many things, but not all. Hammers are great tools, but they don’t do all things well. Knowing which tool to use for a specific job is important, and is one of the reasons why there is no such thing as “simple estate planning”.

*The gift was actually made to an LLC that was owned by the three children, but that is not relevant to any point we are discussing. In legal vernacular, the LLC was a remainderman; the children had no ownership of the house until both of Mom and Dad had passed away. During the lifetime of each of Mom and Dad, they own the house.

NC Case Law: Non-Compete Covenants

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NC Case Law: Security National v Rice and Non-Compete Covenants: -or- Do I Have to Wait? (NC COA16-215, 11/15/2016)

The court here said, among other things, that it was not unreasonable for a Fayetteville full service salon to hold an employee-nail technician who later became a hairdresser and opened her own place to a two-year seven-mile non-compete agreement. While the case was primarily about the proper legal machinations of the courts (for the eggheads, specifically the propriety of summary judgment in the matter), our focus here is solely on the light the court sheds on the non-compete issue as between an employer and employee.

According to the court, to be enforceable a non-compete covenant must be a part of an otherwise valid contract and also requires five further conditions. It must be “(1) in writing; (2) made part of a contract of employment; (3) based on valuable consideration; (4) reasonable both as to time and territory; and (5) not against public policy.” “Not against public policy”, in this context, means that the non-compete must be designed to protect a legitimate business interest of the employer. Most of arguments concern the fourth and fifth requirements. The question on the ground is: how long—and how big an area?

Clients routinely ask us “how long it too long?” when crafting such a covenant, or when trying to determine to what extent they are bound by a covenant that they have already signed.

As to the time and territory requirement: NC does not regard them as independent factors, but considers them in tandem. So, a longer period of time might be acceptable if the geographic area is rather small, and a larger geographic area might be enforceable if the time-period is quite short. A five year limitation is the outer-boundary that NC courts have considered reasonable, but is probably too much in most settings. Going the other way, in Okuma Am. Corp v Bowers the court said a geographic area that it admitted was quite broad was not per se unreasonable given that the period was only six months. In general, and among other things, an employer must show where its customers are located and that the restriction is no more broad than necessary to protect those relationships. A non-compete covenant will rarely be enforced in NC if it reaches to an area where the employer does not actually do business.

The risk an employer runs in seeking to craft a restriction that is too broad is that the whole provision may be found unenforceable: under our famous “Blue Pencil Rule” a NC court will not rewrite or modify contract language to make it acceptable, but rather will simply refuse to enforce it (though it may enforce other provisions elsewhere in the same contract). As the NC Supreme Court recently observed in another case involving a covenant not to compete, the restriction will be enforced “as written or not at all.” Beverage System of the Carolinas v Associated Beverage et ux, filed March 18, 2016. In that case plaintiff-corporations were trying to enforce a non-compete that by its terms covered all of NC and SC, but there were large swaths of the Carolinas where the plaintiffs were not doing business.

NC Case Law: RP Owner Liability

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NC Case Law: Utley v Smith and Premises Liability: -or- The Danger of Collard Greens and Ice. (NC COA16-463, 12/6/2016)

After asking for and receiving directions to the collard greens, Utley tripped over some tomato crates that were staked in an aisle in the outdoor garden area of a Wake County hardware store, tomato crates that Utley had walked past earlier without incident. The question: Was the hardware store liable?

A real property owner in North Carolina owes a duty of “reasonable care” to all lawful visitors. Specifically, according to the NC Supreme Court a business owner’s duty is to “exercise ‘ordinary care to keep in a reasonably safe condition those portions of its premises which it may expect will be used by its customers during business hours, and to give warning of hidden perils or unsafe conditions insofar as they can be ascertained by reasonable inspection and supervision.’ ” Raper v. McCrory-McLellan Corp., 130 S.E.2d 281, 283 (1963). Further, NC Courts have said that an owner “is under no duty to warn invitees of obvious dangers of which they have equal or superior knowledge.” Jacobs v. Hill’s Food Stores, Inc., 364 S.E.2d 692 (1988). In Jacobs, the plaintiff tried to sue the store after falling over a concrete block in a walkway running from the store to the parking lot. The Court said that the store owner had no duty to warn of the obvious danger of the concrete block, and so was not liable for the fall. So here in Utley, the hardware store was not liable.

But it doesn’t end there, though. There may be a condition which is obvious, but which the visitor cannot deal with in any reasonably safe way. If such a condition exists on a business property, but the property is held open to the visitor anyway, the fact that the visitor is aware of the condition won’t protect the owner. The classic example is icy steps which, of course, are always dangerous even in spite of warnings. In such instances, the owner may very well be liable for harm that comes to guests/customers.

So as a business owner, it is critical to deal with such hazards either by curing them or by preventing customers/clients/guests from coming into the range of the danger.

NC Case Law: PLR IRA Beneficiary, No Do Over

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Headline: In PLR 201628004 (July 8, 2016), the IRS ruled that a state court order changing a decedent’s IRA beneficiary after the decedent’s death (to cure a mistake) did not create a designated beneficiary under Code Section 401(a)(9).

Yikes…that sounds boring even to me. Yawn-o-rama. But most of us have retirement accounts. And if you do, this is actually very important.

So here is what happened: the decedent (wonderful word, decedent…so let’s call him Bob) had an IRA. In fact, Bob had two IRAs that named three different trusts as beneficiaries. Bob had the IRAs at a firm where there was a financial advisor that Bob liked and with whom he had a relationship. When Bob’s financial advisor changed firms, Bob took his two IRAs to the new firm (so that he could stay with the financial advisor). The paperwork that Bob signed to accomplish this designated Bob’s estate as beneficiary instead of the trusts. Everyone involved admits that Bob did not intend to change the beneficiaries, only to move the accounts.

When Bob died, the payment of the IRA proceeds into the Estate rather than the trusts presented numerous problems, not the least of which was a large tax bill. This was so because an estate cannot be a designated beneficiary for ‘tax stretch’ purposes. Designated beneficiary must be either an individual or one of certain types of trusts. The trusts Bob had established and had originally named as beneficiaries would have qualified as designated beneficiaries. So Bob’s heirs went to court and got an order paying the IRA benefits to the trusts as originally planned (which, again, would be designated beneficiaries under the applicable rule and so save the tax $). Some problems solved—no doubt for a considerable fee. But that still left the tax bill. And when presented with the question (trying to avoid paying the tax), the IRS ruled that the state court could not change the beneficiary for federal tax purposes, so the tax bill would be calculated as if the estate was the beneficiary.

While this was surely disappointing for Bob’s family, this was not a surprising ruling. And it reinforces what we tell our clients all the time—you can’t say it too often: It is CRITICAL that you check your beneficiary designations, and that they be what you want them to be, because there is no do-over. At least as to taxes…

Transferring Real Estate to Heirs, Part 5

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One of the more frequent estate planning conversations we hear centers upon the transfer of real estate from a person to his-or-her heirs (usually children). This is the fifth and final post in a series of posts reviewing some general information on doing that. As we are typically talking about “the house”, this post will refer to “your house”, but everything here applies to any real estate.

In the previous posts we have considered what happens to property that you own with others (“concurrent interests” if you like fancy-shmancy legalisms), and we talked about leaving property to others through your will (called a “devise”), a trust, what happens if you have no will or trust, and ‘traditional’ life estates.

This brings us to a consideration of the Enhanced Life Estate. To explain this we are going to contrast it with the ‘traditional’ life estate, so reading the previous post might be helpful.

Enhanced Life Estate Deed. With an Enhanced Life Estate Deed, you could transfer the remainder to your child or to a trust that would permit greater control of the property after your death. The Enhanced Life Estate Deed is something of an innovation, a specially designed instrument that is only available in certain states, including North Carolina. It is similar to a traditional Life Estate Deed in that it is a deed that conveys property to another (called a remainderman) at death (of the life tenant). The difference is that while with the traditional life estate (WARNING: LEGALSPEAK COMING) the remainderman’s interest is vested when the deed is signed, with the ELE deed it is NOT vested until you die. In English: with the ELE your child doesn’t have anything until you die. You retain the right to change your mind. That’s right. Without your child’s consent, you can take the property back and give it to someone else. In addition, you have the right to sell or mortgage the property and keep all of the proceeds without your child’s consent. And there are no present tax implications (the IRS calls it an “incomplete gift”).

Just as with a traditional life estate, the remainderman can be one person, multiple people (in equal or unequal shares), or a trust.
PROS:
• There is no probate (with respect to the property) when you die.
• The transfer will be clear of many of the creditor problems you may develop in the future; but if you are having trouble with creditors when you make the transfer it may not protect the house from them.
• This type of transfer will not disqualify you for Medicaid (because it is an incomplete gift).
• You do not have to file a gift tax return (because it is an incomplete gift).
• The Remainderman receives a step-up in basis.
• Mortgage company approval is not required.
• Condo association approval should not be required.
• As of TODAY the property would not be available for estate recovery if you die on Medicaid. (We cannot guarantee that the law won’t change in the future. See below)

CONS:
• DMA hates these things. They have not managed to get rid of them in NC yet, but the day is probably coming. This means that if time is on your side (you have the 60 months) a trust is probably a preferable alternative.
• While your child does not have a vested interest, if your child has any income tax liens or judgment liens, they may have to be paid off before you could sell the property. There are differences of opinion on this point. Until there are court decisions resolving these issues, we must assume that the liens might have to be cleared. Many attorneys (myself included) take the position that if you can sell your property without the signature of your child, then why should you have to pay off the child’s lien in order to sell your property. If you believe that this could be an issue, you should consider the use of an irrevocable trust to serve as remainderman.
• If your child dies before you, the remainder interest goes to her or his heirs. If you are still living and have capacity to sign another deed, this can be remedied. But there is the risk that you would not be. If you anticipate that this could be an issue (e.g., “family land”), you could establish an irrevocable trust to serve as remainderman.

In conclusion, the Enhanced Life Estate Deed is an incredible tool for avoiding probate with minimal downside when compared to the non-trust alternatives, but like most such things should not be done without careful consideration of how it fits with your particular situation and goals.
QPRT. Finally, as an unexpected bonus—at no additional charge, a quick word about QPRTs. While not common in NC, they can be used here. And we have clients that come from areas where they had had past dealings with these critters. We may do a more in-depth look at these in a later post, but now a brief word.

QPRT is an acronym for Qualified Personal Residence Trust. While this could be used for Medicaid planning, its original and still most common use is for estate tax planning. If structured properly, the QPRT will freeze the value of your residence at the time you create the trust and therefore result in significant estate tax savings (because the future appreciation of the home is removed from your taxable estate). This is helpful assuming, of course, that estate tax liability is an issue and that the home will continue to appreciate. It is used much more in the Northeast, where not only are house values often considerably higher than here, but many states also impose their own estate tax in addition to the federal tax, and so the impact of the value of the house is more of an issue than here.

The method: you establish a properly-drafted QPRT and transfer your house to the trust. The Trust gives you an unqualified right to possession of the house for a set period of time (the trust term). Then comes the rub: at the end of the term you must relinquish the house (to the kids). It may be worth it, but you want to proceed cautiously after thorough analysis. The decision requires balancing the potential estate tax savings, based in part on current interest rates and the effect of the projected appreciation of the property on your overall estate, against both the consequences of relinquishing ownership to the next generation and the costs involved. The accounting may not be simple. Careful consideration should be given to both tax and non-tax consequences.

As always, this conversation is of a general nature and is NOT A SUBSTITUTE for coming in and discussing YOUR PARTICULAR SITUATION with us. We will offer you coffee, and we rarely bite. You might see a cat. Also, this conversation is based on North Carolina law at the time it was written, and assumes that both you and the real estate in question are in North Carolina.

Transferring Real Estate to Heirs, Part 4

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One of the more frequent estate planning conversations we hear centers upon the transfer of real estate from a person to his-or-her heirs (usually children). This is the fourth in a series of posts reviewing some general information on doing that. As we are typically talking about “the house”, this post will refer to “your house”, but everything here applies to any real estate.

In the previous posts we have considered what happens to property that you own with others (“concurrent interests” if you like fancy-shmancy legalisms), and we talked about leaving property to others through your will (called a “devise”), a trust, and what happens if you have no will or trust.

This brings us to a consideration of Life Estates. There is the traditional life estate discussed here, and next time we will discuss the enhanced life estate.

Traditional Life Estate Deed. You could do execute a Life Estate Deed under which you retain the right to possession and enjoyment for your lifetime, and upon your death (or the death of the surviving spouse), the remainder (what is left after your life estate terminates) will pass to the child/ren (here known as the “remainderman”, whether one or more) when you die. Usually this is just called a “Life Estate”, we are calling it “Traditional” to distinguish it from the “Enhanced Life Estate” which we will discuss next time.

Life estates are quite old, and divide ownership based upon time. Person A owns until a certain named person (who may or may not be person A) dies, after that Person B owns. So I could give a house to Mary for the life of Mary, then to Susan. Susan gets the house when Mary dies, but Susan owns that part of the house NOW. (Even though Mary is alive and Susan has no right to even be in the house now.) So Susan’s interest, which is called a “remainder”, is “vested”. This will be important when we get to Enhanced Life Estates, but it also can have implications for taxes and liens.
The remainderman can be one person, multiple people (in equal or unequal shares), or a trust.

PROS:
• There is no probate (with respect to the property) when you die.
• The transfer will be clear of all of the creditor problems you may develop in the future, including Medicaid Estate Recovery. Bullet-Proof. In fact, the ONLY thing that is without using a trust. (But if you are having trouble with creditors when you make the transfer it may not protect the house from them.)
• This type of transfer will not disqualify you for Medicaid IF: the deed meets certain technical requirements AND IF EITHER a) the child or children actually pays you FMV for their interest in the property (there are tables for calculating this amount), OR b) the transfer happens MORE than sixty months before you need Medicaid.
• The Remainderman receives a step-up in basis if they receive the property when you pass away (but NOTE that if you decide to sell before you pass away they could owe capital gains tax).

CONS:
• Your child OWNS a vested future interest in your house. He or she has no present interest and can not throw you out, or even be there without your permission while you are living, but the transfer of the future interest is irrevocable (unless your child signs a deed).
• If you gift the interest (as defined by the IRS), you will probably have to file a gift tax return (though this does not necessarily mean tax would be owed).
• If there is a gift, and if you (or your spouse) need Medicaid in the following 60 months, you will face a penalty in the form of a waiting period during which you are ineligible for benefits.
• As a practical matter, you cannot sell your house without your child’s consent (signing the deed) AND, if he or she is married, the spouse signing as well.
• As a practical matter, you cannot borrow against your house without your child’s consent (signing the deed of trust and, probably, the note) AND, if he or she is married, the spouse signing as well.
• Your child OWNS a future interest in your house, so if he or she has creditor problems, the creditors may get that portion of your house (but not as long as you are alive). If this is an issue, you could establish an irrevocable trust to serve as remainderman.
• If your child has any income tax liens or judgment liens against the child’s share, they must be cleared before the property could be sold. If this is an issue, you probably should establish an irrevocable trust to serve as remainderman.
• If your child dies before you, the remainder interest goes to her or his heirs, and there will be nothing you can do about it. (Whereas with an Enhanced Life Estate, will, or trust you could change the documents.) Again, if this is an issue (e.g., “family land”), you could establish an irrevocable trust to serve as remainderman.
• If you own a condo, association approval may be required.

As always, this conversation is of a general nature and is NOT A SUBSTITUTE for coming in and discussing YOUR PARTICULAR SITUATION with us. We will offer you coffee, and we rarely bite. Also, this conversation is based on North Carolina law at the time it was written, and assumes that both you and the real estate in question are in North Carolina. Mobile homes can cause additional complications that are not addressed here. Next time, we will discuss enhanced life estate deeds and a bonus topic. Until then…

Transferring Real Estate to Heirs, Part 3

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One of the more frequent estate planning conversations we hear centers upon the transfer of real estate from a person to his-or-her heirs (usually children). This is the third in a series of posts reviewing some general information on doing that. As we are typically talking about “the house”, this post will refer to “your house”, but everything here applies to any real estate.

In the last post we considered what happens to property that you own outright (as opposed to having a life estate, joint tenancy with survivorship, etc.) at your death. So we talked about leaving property to others through your will (called a “devise”), and we talked about what happens if you have no will.

1. Transfer to/through a Living Trust. You can establish a Revocable Living Trust, and then draft a deed transferring your house (or any other real estate and most other types of assets) to the Trust. Any property owned by the Trust when you pass away avoids probate. The Trust Agreement will then control what happens to the house (or anything else) when you pass away. The options are virtually limitless. You could have the trust distribute the house to one or more persons, or hold it in further trust and allow someone to live in the house. Or it could direct the trustee to sell the house and pay the net proceeds to one or more people/organizations. If the trust is property drafted, it will protect the house from your beneficiary’s creditors and unhappy spouses. (This sort of trust will NOT protect the house from your creditors.) Note: Unlike some other states, it is NOT enough merely to draft a trust agreement that mentions the house or a declaration of trust. In North Carolina, there MUST be an ACTUAL DEED that transfers the house into the Trust.

PROS:
• During your lifetime you are free to do anything you like.
• You decide who gets your house, subject to certain claims of creditors, maybe your spouse, etc.
• Your heirs (beneficiaries) get a step-up in tax basis when they inherit the house.
• If your heirs (beneficiaries) are your spouse or children and there is a mortgage on the house when you die, they don’t have to pay off the mortgage immediately, and they do not have to assume it; but they do have to keep it current.
• The house is protected from most of the creditors of your beneficiaries (if trust agreement is properly drafted).
• The house is protected from the unhappy spouses of your beneficiaries (if trust agreement is properly drafted).
• There is generally almost zero risk of litigation (if trust agreement is properly drafted).
• Very economical and easy after your death.
• It is a private arrangement, as opposed to probate, which is public.
• If there are to be multiple beneficiaries and you anticipate that they may not get along, this allows the Trustee to deal with the property without the necessity of forging agreements.
• Lends itself well to complex arrangements (if such are needed).
• Allows for genuine long-term control of the property after you pass away.
• You can transfer mortgaged property to your Trust without the approval of the mortgage company.
• If you are married, North Carolina law now allows you to maintain the protections of TbyE even though you have transferred the property to your Trust.

CONS:
• Subject to the claims of your creditors.
• The initial cost will be higher than for a will or a deed, though the long-run cost will likely be less than the use of a will.
• If poorly done, it can really make a mess of things.

2. Transfer to/through an Irrevocable Trust. You could establish an Irrevocable Trust, and then draft a deed transferring your house (or any other real estate and most other types of assets) to the Trust. There are many different sorts of Irrevocable Trusts and they vary greatly. But as a general rule, one big “pro” will be added to the list of “pros” for a Living Trust. It is this: that as a general matter the property in the Trust IS protected from your creditors. (There are some important exceptions to this.) But all good things come at a price, and the price here is a big “con” that is added to the list of “cons” for a Living Trust. It is this: loss of control. That is right, once you transfer property to an irrevocable trust there is NO getting it back. And there is a second con: since the ability to modify an irrevocable trust is quite restricted, if it is not done right the first time there may well be no fixing it.

3. Transfer to/through an LLC or Corporation. Many of our clients own rental or business real estate in an LLC or a Corporation. So the name on the deed is not a person, but is the name of an LLC or Corporation. This means that the specific piece of real estate is not an asset to leave to someone, because it is owned by the LLC or Corporation. But your interest in the LLC or Corporation IS AN ASSET that you leave to your heirs. They do get a step-up in basis in the value of the LLC or Corporation upon your passing. If there is concern that the prospective heirs won’t get along, you can make the LLC subject to an Operating Agreement (or the shares in the Corporation subject to a Shareholders’ Agreement) to facilitate the smooth transition. If you have a Trust, and you have transferred ownership (or equitable ownership) to the Trust, and the Trust is properly drafted, this should not be an issue.

On a related note: The setting up of Partnerships to own real estate used to be quite common. (LLC law was relatively undeveloped and many did not think the LLC a credible option. Also, and this may be a surprise to you, but attorneys as a group tend to be creatures of habit and are rather biased against new things.) We still see quite a few Partnerships. Upon a quick glance, Partnerships can look like an LLC (they share the trait that they don’t pay taxes but pass profit and loss directly to the owners to pay the tax). But Partnerships are not the same as LLCs. Partnerships are very prone to big and expensive problems when a partner dies. If you have one in NC, and can’t explain why it should be a Partnership and not an LLC, come talk to us. (Some states do not give LLCs favorable tax treatment, and the level of protection provided by an LLC varies greatly between states. If you are not in NC, talk to someone in your state about your needs.)

As always, this conversation is of a general nature and is NOT A SUBSTITUTE for coming in and discussing YOUR PARTICULAR SITUATION with us. We will offer you coffee, and we rarely bite. Also, this conversation is based on North Carolina law at the time it was written, and assumes that both you and the real estate in question are in North Carolina. Mobile homes can cause additional complications that are not addressed here. Next time, we will discuss life estates. Until then…

Transferring Real Estate to Heirs, Part 2

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This is the second of about four blog posts that addresses ways to transfer ownership of real estate to your children. This is one of the more frequent estate planning conversations we engage in. There is a lot of bad information out there on the topic. These posts form a brief primer of the current options in North Carolina.

In the last post we considered giving your property outright to your children now, and transferring a partial interest to them now as joint tenants. Today we look at “devises”. Devise is an old-time legal word for a transfer of real estate at the death of an owner by will or intestacy. There are two ways that devises happen:

1. Transfer by intestacy (a.k.a. do nothing). If you die owning your house ‘in your name alone’ and with no will (called dying “intestate”), North Carolina’s intestacy statute will determine who owns your property after you pass away.

PROS:
• Your heirs get a step-up in tax basis (though there are better ways of doing this).
• If your heirs are your spouse or children and there is a mortgage on the house when you die, they don’t have to pay off the mortgage immediately, and they do not have to assume it, but they do have to keep it current. (Again, there are better ways of accomplishing this.)
• Free today.

CONS:
• May be very expensive tomorrow.
• There may be a substantial risk of challenge, depending upon your personal situation. Specifically, there could be litigation to determine which people qualify as your heirs, and in what percentages.
• The transfer is subject to the claims of creditors (your creditors could force your heirs to sell the house to pay them).
• May require probate administration (to determine heirs or clear creditor claims).
• WILL require some court administration to sell within three years of your death (must run Notice to Creditors).
• Heirs may lose the property to creditors.
• If your house has a mortgage, your heirs get a house with a mortgage.
• Your heirs may not be who you think they are. (Many people assume that their spouse “automatically inherits everything”. This is often not true.)
• If any of your heirs are minors, or incapacitated, the house cannot be sold with a special proceeding being brought in Superior Court.
• If any of your heirs are married, and the spouse(s) of the heir(s) will not cooperate, there could be big (read: expensive) problems.
• If your heirs have judgments against them, the judgments attach to the real estate upon your death.

2. Transfer by will. So instead of dying intestate, you could draft a will. (A person that dies with a valid will is said to die “testate”.) This conversation will presume that the will is properly drafted and executed, and can be admitted to probate.

You can draft a will leaving your house to anyone you wish. However, if you own the house as tenants-by-the-entireties and your spouse outlives you, OR if you own as joint-with-right-of-survivorship (JROS), what your will says does NOT matter—your spouse (or the joint tenant if JROS) get the property (subject to any liens on the house, of course). But Note: Even with a will, if you are survived by your spouse your surviving spouse has claims against your property EVEN IF your will ‘disinherits’ him or her. Obviously this can be a major issue. It stems from the fact that surviving spouses have statutory rights with regard to the estate of their deceased spouse, which the deceased spouse’s will does not change.

Further Note: The fact that your will says that the house is to be sold and the money divided does NOT mean that your Executor can do this. Such a provision requires VERY specific language to be in the will (in North Carolina), and we see MANY wills that have such a provision but do not have the necessary language to make it happen.

PROS:
• You decide who gets your house, subject to certain claims of creditors, your spouse, etc.
• Your heirs get a step-up in tax basis when they inherit the house.
• If your heirs are your spouse or children and there is a mortgage on the house when you die, they don’t have to pay off the mortgage immediately, and they do not have to assume it, but they do have to keep it current.

CONS:
• There is a certain risk of challenge. The degree of that risk depends upon various factors, most of which relate to how well your will is drafted and your personal situation.
• The transfer (called a “devise”) is subject to the claims of creditors (because your creditors could force your heirs to sell the house to pay them). In short, your heirs may lose the property to your creditors.
• Your heirs could lose the house to their creditors.
• May require probate administration.
• WILL require some court administration if your heirs wish to sell the house within three years of your death (must run Notice to Creditors).
• If the heirs won’t get along, or any of them are minors, or incapacitated, or have spouses that may not cooperate, or have judgments entered against them, it is important that the will give someone the power to sell, which requires VERY specific language, otherwise litigation may result.

In the next couple of posts we will consider transferring your house to/with a trust, and various life estate options. Until then…

Transferring Real Estate to Heirs

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One of the more frequent estate planning conversations we hear centers upon the transfer of real estate from a person to his-or-her heirs (usually children). There is a lot of bad information out there on the topic. So this is the first of about four blog posts that will address this issue. Together, they form a brief primer based upon the current climate in North Carolina. As we are typically talking about “the house”, this post will refer to “your house”, but everything here applies to any real estate located in North Carolina (unless otherwise noted).

As always, this conversation is of a general nature and is NOT A SUBSTITUTE for coming in and discussing YOUR PARTICULAR SITUATION with us. We will offer you coffee, and we rarely bite. Also, this conversation is based on North Carolina law at the time it was written, and assumes that both you and the real estate in question are in North Carolina. There are options not covered here, these are the most common. Mobile homes can cause additional complications that will be briefly mentioned in one of the later posts.

The first transfers we will consider involve giving a present interest in your house to your children.

1. Outright Transfer to a Child (or Children). Many people decide that they will “go ahead and give our house to our kids” with the idea that this will “protect it from the nursing home”. If you transfer title to your home to a child (or children), the child (or children) owns the property. This is a gift. There will be no probate when you die, of course, because they already own it. And that means that the nursing home won’t get it when you die (assuming you don’t already owe them money), because it is not there to get. Remember that any transfer of real estate that does not clear (pay-off) liens already on the real estate is still subject to those liens, so if there are judgments or mortgages they go with the property.
But the nursing home isn’t as much of an issue as is Medicaid. If you don’t pay the nursing home, they throw you out. So people go on Medicaid, but people who just gave away a house are denied. So there are problems with this approach.
And there is another issue. You need a place to live, and giving your house away (even to your kids) complicates that. Sometimes doing this makes sense (I suppose…), but there are HUGE potential problems that should make you think twice before putting title in the name of your child.

PROS:
• There is no probate when you die.
• The transfer is clear of creditor problems you may develop in the future, but if you are having trouble with creditors when you make the transfer it may not protect the house from them.
• Deeds are cheap.

CONS:
• Your child OWNS your house. He or she can throw you out.
• Your child OWNS your house, so if he or she has creditor problems, the creditors may get your house (and throw you out). If he or she files bankruptcy, the bankruptcy trustee could sell your house (and throw you out). If your child gets divorced, your house could be lost to the now ex-spouse (who could throw you out). If your child does not outlive you, you will have problems. Your child’s heir (or creditors) will own your house (and throw you out). Picking up on a theme?
• If you have a mortgage, they may have to agree to the transfer in writing. They likely will not, but even if they do they will probably charge you a fee.
• If you are in an age-restricted community, the transfer may be prohibited by the covenants.
• If you are presently receiving property tax discounts that are offered to certain elderly or disabled citizens (that fall below certain income levels), you will no longer qualify for these discounts.
• When you give your children your house, you also give them your basis. This means that they are likely to have a capital gains tax bill in their future.
• This is a gift, so you will probably have to file a gift tax return (though this does not necessarily mean tax would be owed).
• This is a gift, so if you (or your spouse) need Medicaid in the following 60 months you will face a penalty in the form of a waiting period during which you are ineligible for benefits.
• Did I mention that if you do this your child owns your house?

2. Create a Joint Tenancy with Survivorship with a Child (or children). If you transfer title to a child (or children), the child (or children) owns the property. So rather than your kids owning the whole house, they have a partial interest (called a “concurrent interest”). You keep your foot in the door. Merely “putting their name on the deed” isn’t enough, as that would create a tenancy-in-common. The deed must clearly create a joint tenancy. And since not all joint tenancies have the right of survivorship, it must specify that as well. Note that if you own your house in a joint tenancy with right of survivorship, the deed—and NOT your will, controls what happens to the house when you die unless you are the last person whose name is on the deed to die.

This could be done as a gift (your child doesn’t pay you for the interest). Or they could pay you for it (which, if done right, will generally maintain your Medicaid eligibility). Either way, there will be no probate when you die (related to the house), of course, because of the survivorship clause in the deed. Any transfer of real estate that does not clear (pay-off) liens already on the real estate is still subject to those liens, so if there are judgments or mortgages they go with the property. Sometimes doing this does make sense, but it should not be done without careful examination of the consequences. In general:

PROS:
• There is no probate (with respect to the property) when you die.
• The transfer will be clear of many of the creditor problems you may develop in the future; but if you are having trouble with creditors when you make the transfer it may not protect the house from them.
• This type of transfer will not disqualify you for Medicaid IF: the deed meets certain technical requirements AND if the child or children actually pays you FMV for their interest in the property (so if you sell your child a 1% interest, he or she must pay you 1% of the value of the property, and you must be able to prove this actually occurred).

CONS:
• Your child OWNS a present interest in your house. He or she can not throw you out, but you cannot throw him or her out, either.
• Your child OWNS a present interest in your house, so if he or she has creditor problems, the creditors may get that portion of your house (and cause your grief). If your child files bankruptcy, the bankruptcy trustee could cause your grief (though they could not take your portion of the house). If your child does not outlive you, it did not work.
• If you have a mortgage, they may have to agree to the transfer in writing. They likely will not, but even if they do they will probably charge you a fee.
• If you are in an age-restricted community, the transfer may be prohibited by the covenants.
• If you are presently receiving property tax discounts that are offered to certain elderly or disabled citizens (that fall below certain income levels), you will probably no longer qualify for these discounts.
• If you GIVE your children a joint interest in your house, the part you gave them comes with your basis. The part they receive when you die gets a step-up in basis. How big a deal this is depends upon the numbers involved.
• If you SELL your children a joint interest in your house, the part you sell them has a basis that is the amount paid that they paid you. The portion of the property they receive when you die gets a step-up in basis. If you sell them an interest for less than FMV, the IRS will call the difference a gift.
• If there is a gift (as defined by the IRS), you will probably have to file a gift tax return (though this does not necessarily mean tax would be owed).
• If there is a gift, and if you (or your spouse) need Medicaid in the following 60 months, you will face a penalty in the form of a waiting period during which you are ineligible for benefits.
• As a practical matter, you cannot sell your house without your child’s consent (signing the deed) AND, if he or she is married, the spouse signing as well.
• As a practical matter, you cannot borrow against your house without your child’s consent (signing the deed of trust and, probably, the note) AND, if he or she is married, the spouse signing as well.

The outright transfer actually gives your whole house to someone else. There are three common form of concurrent interests. One is joint tenancy, discussed above. The second is tenancy-by-the-entireties, which is only available to married couples. It is a really big deal, and we will discuss it in a future post.

The third is the tenancy-in-common (TIC), which is very common. Unlike joint tenancy, a TIC creates an absolute ownership of ‘part’ of the property. It is like the Brady Bunch episode where Peter and Bobby divide their room with tape. Bobby gets half the room, Peter gets the other half. If Peter dies, Bobby still only has half the room—Peter’s heirs (or creditors) now have the other half. So we are not really discussing that form here, because from an estate planning and creditor protection standpoint it only creates more problems.

More in the next post…