PARENTS GIFTS IN REAL ESTATE TRANSACTIONS

PARENTAL GIFTS TO CHILDREN ARE A HOT TOPIC ON “LEGAL-LINE”……WHAT EVERY BROKER SHOULD KNOW ABOUT GIFTING………

Matters of gifting arise in our practice on a continuing basis. Recently a Broker contacted “Legal-Line” inquiring on behalf of parents who were interested in “helping” their son and daughter-in-law to acquire a new single-family residence, but were limited in their opinion by a $14,000.00 gift limitation. The problem was that $14,000.00 was less than they wanted to give and they had heard that gifts above this level were “taxable” and were concerned as they did not want to pay any gift tax.

This is an area of practice that we encounter on an on-going basis. There are plenty of misunderstandings out there on gifting and taxes. Especially now with new tax laws coming into existence, the questions only increase. I hope in this short writing to clarify some of those matters and provide all our readers some tax information that can be valuable for you in your practice.

MORE AND MORE PARENTS WISH TO GIFT FUNDS TO THEIR KIDS TO BUY HOMES

With the increased cost of homes and with more conservative lending standards, it is anticipated that a significant number of parents are going to gift cash to their children to enable them to purchase their first home.

ANNUAL GIFT EXEMPTION IS $15,000.00 PER DONEE IN 2018

This is where we start. The annual gift exemption has been at $14,000.00 since 2013 so many of our readers will remember that number. It is $15,000.00 per donee per year starting now in 2018. This is a long-established exemption to FEDERAL GIFT TAXES. [There is no GIFT TAX in Washington state. There is an ESTATE tax, but no gift tax in Washington State].

This means that each individual can give to EACH DONEE up to $15,000.00 per year with no gift tax and no gift tax return required. So, if a husband and wife wanted to gift to their son and daughter-in-law they could gift a total of $60,000.00 under this rule. A husband can gift $15,000.00 to his son and daughter in law and the same can be said for the wife to gift to son and daughter in law as well. No reporting to the government required.

WHAT IF THE PARENTS WANTED TO GIFT $200,000.00 OR EVEN MORE?

This is the situation we experienced recently in a “legal-line” inquiry that has prompted this weekly update. The parents wanted to gift $200,000.00, but were again concerned about gift taxes. This is a valid concern. However, we have ways of working through this situation with no tax concerns whatsoever.

IT’S CALLED “THE UNIFIED GIFT AND ESTATE TAX CREDIT”

Now that is a mouthful. At the Federal level, each individual has during his or her life a credit that can be used for gifts during life and also for gifts at death. The amount has changed over the years and was, at one time, as low as a million dollars per individual.

With the new tax law coming into existence as this article comes out, the new tax law will change things now for the “better” (at least until 2025 when the new law sunsets). The new law allows an individual approximately $11.2 million in gift and estate tax exemptions and with portability a married couple can exempt $22.4 million in assets against their estate value. For the vast majority of Americans, there is no longer a federal estate tax.

What does this mean? It means that each of us has a credit on the books at the federal government. That credit is now over $11 million dollars that we can use as we may to gift DURING OUR LIFE or UPON OUR DEATH or BOTH!!! For most of the population this amount is well above their asset base and allows a freedom of gifting not realized in the past.

SO HOW WOULD OUR “LEGAL-LINE” PARENTS MAKE THEIR $200,00.00 GIFT?

They wanted to gift $200,000.00 to their son and daughter in law.

First: we would (as above) take advantage of the $15,000.00 per person per year and that would allow the parents to freely gift $60,000.00 with no tax consequences or reporting whatsoever. [Look at the calculations above].

Second: we would (as above) take advantage of the huge federal gift credit and freely gift $70,000.00 by the husband and $70,000.00 by the wife (for a total of $140,000.00) with no gift tax consequences EXCEPT they have to file a gift tax return in the year of the gift, but no tax to pay just an informational return to file.  Easy. Quick.

PRACTICE POINTER: If you have parents out there thinking of gifting, it is a marvelous way to help the kids get into their first home. They need NOT be focused on the limitation of the $15,000.00 rule. We are happy to consult and assist parents in utilizing their “Uniform Federal Gift and Estate Tax Credit. Just call our office.

WHICH WILL CONTROLS? THE NEWER? THE OLDER?.....BOTH?

In our law practice, we often encounter inheritance disputes involving different drafts of a will.  We recently encountered a situation through a local real estate broker who was looking for a title company to insure a transaction where the personal representative of the estate was also the only heir. The real estate in question was conveyed by the personal representative to himself so he, personally, was the seller. Seems like no problem. Right?

The problem was in the probate estate proceeding itself where another party made claims in the estate court proceeding claiming that the will probated was NOT the last will and that another was the last will. The problem was that will contest did not move forward because of a procedural flaw by that party, but the possible will contest was still there. It was still an open issue with the probate court notwithstanding the case was closed.

Title companies all around Washington state were reluctant to insure the new buyer as the “potential” claim against sellers could still come up. Ultimately the transaction did recently close, but the insuring title company make certain that the buyer KNEW (and really KNEW) that his title was subject to potential attack and that the seller did not agree to defend the title. The title company could insure the sale, but limited its insurance coverage to matters other than the potential claim.

I bring this matter up as it is one of those things that can cause a huge obstacle to close a sale transaction. As we were working on this matter, one of our attorneys found a very recent case (2017) right on point that we used with the title company in analyzing the underlying fact pattern. I share that case analysis in this weekly update.

IN THE MATTER OF THE ESTATE OF OTTMAR

When drafting a new will, it is best practice to be cognizant of the terms of a previous will and the material changes in anticipation of potentially unhappy parties. In our practice, we often take great pains to make sure that the will we are drafting will be deemed to be the last will and testament of the client. However, such is not always the case and certainly was potentially not the case in the recent title matter with our office.

A recently handed down Division 3 Court of Appeals decision, Matter of Estate of Ottmar, WL 6343646 (2017) illustrates how careful drafting could have helped avoid a will contest which resulted in the terms of an older will controlling over the terms of a newer will. [Our fact pattern above was just like this].

*****In 1987, Dennis and Elizabeth were married.

*****Both were previously married and Dennis had a son, Thomas, from his previous marriage.

*****Dennis and Elizabeth purchased a home in Spokane and lived there during their long and happy marriage while Dennis maintained a good relationship with Thomas.

*****In 2005, Dennis hired his longtime attorney to prepare a will which divided Dennis’ estate equally between Elizabeth and Thomas.

*****In 2007, Dennis began having health problems.

*****In December 2015 and January 2015, Dennis had a series of serious medical issues.

*****In January 2015, Dennis was admitted to the hospital for the final time. According to Elizabeth, she called Dennis’ attorney and asked about the existing will and was advised that the attorney did not have a copy. The attorney who had drafted the 2005 will had retired and referred Elizabeth to another attorney if Dennis desired a new will. However, according to Dennis’ former attorney, Elizabeth never asked about the 2005 will and if she had, he would have been able to produce a copy.

*****Next, Elizabeth arranged for a third attorney to draft a new will for Dennis.

*****On February 9, 2015, the attorney visited the hospital, explained the purpose of the new will to Dennis. Elizabeth then read the terms of the new will to Dennis and Dennis executed the new will. Under the 2015 will, Elizabeth inherited all of Dennis’ estate.

*****By February 11, 2015, Dennis’ health continued to deteriorate and he began palliative care. Dennis called Thomas and spoke with him but Thomas could not understand what he was saying so the call was brief. Elizabeth texted Thomas asking him if he understood that Dennis was saying goodbye. Thomas said he did not understand and wanted to visit Dennis but Elizabeth stated that he could not. During his time at the hospital, Dennis refused all visitors other than Elizabeth and Elizabeth did not allow anyone else to see Dennis.

*****On February 14, 2015, Dennis passed away.

*****Elizabeth submitted the 2015 will for probate and, in turn, Thomas filed a will contest.

RULING AT THE TRIAL COURT LEVEL

At trial, the superior court invalidated the 2015 will on two (2) bases: lack of testamentary capacity and undue influence resulting in the 2005 will controlling the disposition of Dennis’ estate. Elizabeth appealed.

RULING AT THE COURT OF APPEALS LEVEL

The Court of Appeals affirmed the trial court’s ruling regarding undue influence and, in doing so, declined to reach the issue of testamentary capacity. In affirming the trial court’s ruling, the Court of Appeals held that (1) Elizabeth had an opportunity for undue influence because of her close relationship with her husband leading up to his death and because she was involved in all aspects of his personal and financial affairs; (2) Elizabeth actively participated in the drafting of the 2015 will because she was involved with its preparation and execution; and (3) Elizabeth received an unusually large or unnatural bequest that changes to the 2015 will from the 2005 will resulted Elizabeth inhering all of Dennis’ estate and Thomas was completely disinherited inconsistent with 2005 will.

However, in making its ruling the Court of Appeals noted had the 2015 will made any disposition to Thomas, the case may have been decided differently. However, the total disinheritance of Thomas and the lack of evidence showing Dennis had had a change in heart between 2005 and 2015 resulted in the Court of Appeals affirming the trial court decision and invalidating the 2005 will.

PRACTICE POINTER: (Yours Professionally). Get your title commitment ordered as quickly as possible especially in estate sale transactions. Pay close attention to the title commitment. If there are going to be impediments to closing start talking with your title officer well in advance of accepting an offer. Many offers were accepted in this case resulting in much time and effort spent only to discover that the proposed deal was not insurable.

PRACTICE POINTER: (Yours Personally). The practice pointer here is two (2) fold. First, when dealing with estate matters do not leave things to the last minute to ensure an orderly estate planning process. Second, when dealing with estate matters always consult with an attorney to anticipate potential challenges down the road to ensure that your intentions are stated in your will and carried out through probate.

WHAT IS THE APPROPRIATE DEED TO USE IN AN DECEASED ESTATE SALE CLOSING?

This has been a question that our firm has been involved in on many occasions and was the source of a call just recently from a local Broker over on the Eastside seeking clarification and confirmation.

We represented an estate a while back that was sued because it used the incorrect deed at closing. One of the issues was whether the Listing Broker had any liability for making sure the proper deed was utilized for that sale.

The facts are not that complicated:

****Seller was an estate of a deceased in King County, Washington. Personal Representative had been appointed appropriately by the court and had full power to sell the property without any further intervention of the court.

****Personal representative had never physically seen the real property and, in fact, lived in another state. Listing Broker appropriately listed the property for sale.

****Purchase offer came through by a cash purchaser and closed on that sale in escrow with estate conveying the real estate to the purchaser by Statutory Warranty Deed. Life was good. No problems.

****Purchaser, in anticipation of building fences along another border of the subject property, had the whole property surveyed only to find out to their initial dismay (and subsequent delight) that a forty (40) foot strip along the whole 480-foot boundary line had been adversely possessed by the neighbor and there was in place a fence there and all elements of adverse possession had been met years earlier. That 40ft x 480ft area had been adversely possessed by the adjoining land-owner.

****The purchaser never even imagined that property was part of the purchase, but it WAS INCLUDED in the legal description in the Statutory Deed and was a basis for a claim of breach of warranty of title against the estate and the escrow company.

****The escrow/title company was dismissed from the lawsuit as they told the court that they closed the real estate transaction according to the Purchase and Sale Agreement and that since it said (as contained in the state-wide forms) to use a Statutory Warranty Deed (and they did) that they should be dismissed. They were dismissed and rightfully so.

****The estate had, by Purchase and Sale Agreement, agreed to sell the real property. If they had not used a Statutory Warranty Deed, but a PERSONAL REPRESENTATIVE’S DEED, which is appropriate, then the extent of warranties offered would be far less reaching. The estate could purchase the land from the adversely possessing party in settlement of the lawsuit. That cost the original Estate seller a substantial amount of money.

****The estate looked to its Listing Broker to explain why the Listing Broker in taking a listing for an estate sale of property did not change by Addendum the type of Deed to the one appropriate for that type of transaction. The Broker and estate settled that issue. Was the Listing Broker negligent? I think so?

PRACTICE POINTER:  In any transaction where you are representing the seller and the seller is an estate of a decreased person, make certain that you draft an appropriate Addendum changing the deed specified in the statewide forms to a Personal Representative’s Deed. Quick. Easy. Easy to explain to the buyer and their broker. This is the appropriate deed used in decreased estate transactions.

GOOD NEWS!!!!  You now have your escrow and title company also looking out to protect you (as they protect themselves as well). You see, until last year a Personal Representative Deed had to be prepared by an attorney. Now your friendly LPO at your escrow dept. can draft it as part of their Limited Practice Officer’s license. That’s right. It is now one of the LPB approved forms for LPO’s to choose and prepare. This is good news.

PRACTICE POINTER TO LPO’ READERS:  I would focus on requiring an Addendum every time it is appropriate as I am not convinced that you are relieved of liability especially now with the ability of an LPO to prepare this deed. Escrow folks need to be vigilant of this Deed requirement as well.

CAPITAL GAINS TAXES AFTER THE NEW TAX LAW IS IN EFFECT

We have had many calls from clients and our fellow Brokers out in real estate land asking about the effects of the new tax laws coming into effect this next year practically related to capital gains and real estate investment. There has been so many articles and commentators out there talking today so that a few pieces of information on how the tax law changes can affect real estate investors I think can provide some real value for our readers.

TAX DEFERRED EXCHANGES ARE STILL ALIVE AND WELL, THANK YOU, AFTER THE NEW TAX CHANGES

You may not know this, but Section 1031 tax deferred exchanges were potentially on the chopping block as the Congress looked at tax law changes. While in existence since 1921, many politicians looked at tax exchanges as enhancing the wealth of real estate investors and looked to take that benefit away. At the end of the day, Section 1031 exchanges are with us, but with a major change.

PERSONAL PROPERTY TAX DEFERRED EXCHANGES WERE ELIMINATED FROM TAX DEFERRAL

There are TWO (2) types of tax deferred exchanges: One for personal investment property; another for real estate investment property. Our readers are certainly aware of real estate exchanges, but you may not

be aware of personal property exchanges. THEY ARE HUGE!!! They involve fleet leases of vehicles, aircraft, oil and gas mine leases and the like. They have nothing to do with real estate.

In short, these types of personal property tax deferred exchanges have been eliminated by the law. They are gone. So many have called our office believing that all exchanges are gone that we attempt to make it clear here. REAL ESTATE tax deferred exchanges are alive and well after the new law changes. We continue as we have before. Again, REAL ESTATE tax deferred exchanges are alive and well after the tax law change.

CAPITAL GAINS TAX MATTERS REALLY REMAIN THE SAME AFTER THE NEW LAW CHANGE

Again, nothing has changed in the basic capital gains tax calculations because of the tax law change.

Let us begin with long-term capital gains. Long-term capital gains are still defined as gains made on assets that you hold for over a year, while short-term capital gains come from assets you hold for a year or less. Long-term gains are taxed at rates of 0%, 15%, or 20%, depending on your tax bracket; while short-term gains are taxed as ordinary income.

3.8% OBAMA-CARE SURCHARGE STILL APPLIES!!!!... WAS NOT REPEALED!!!!!!

Also, for both types of capital gains, it's worth noting that the 3.8% net investment income tax that applies to certain high earners will stay in place, with the exact same income thresholds. This is part of the Affordable Care Act, which Congress has not successfully repealed or replaced. So this tax remains.

The long-term capital gains tax rates of 0%, 15%, and 20% still apply. However, the way they are applied has changed slightly. Under previous tax law, the 0% rate was applied to the two lowest tax brackets, the 15% rate was applied to the next four, and the 20% rate was applied to the top bracket.

Under the new tax law, the three (3) capital gains income thresholds don't match up perfectly with the new tax brackets. Instead, they are applied to maximum taxable income levels, as follows:

Long-Term Capital Gains Rate	Single Taxpayers	Married Filing Jointly	Head of Household	Married Filing Separately
0%	Up to $38,600	Up to $77,200	Up to $51,700	Up to $38,600
15%	$38,600-$425,800	$77,200-$479,000	$51,700-$452,400	$38,600-$239,500
20%	Over $425,800	Over $479,000	Over $452,400	Over $239,500

Data source: Tax Cuts and Jobs Act.

If you look at the tax bracket charts later in this article, you might notice that these thresholds are based on the previous tax brackets. In other words, your long-term capital gains taxes in 2018 will be virtually the same as they would have been if no tax reform bill had passed.

DON’T FORGET THAT SHORT TERM CAPITAL GAINS ARE STILL TAXED AS ORDINARY INCOME!!

On the short-term capital gains side, short-term gains are still considered ordinary income, so the effect is more obvious. If your marginal tax rate has changed, your short-term capital gains tax will change as well.

For comparison, here are the newly passed 2018 tax brackets:

Marginal Tax Rate	Single	Married Filing Jointly	Head of Household	Married Filing Separately
10%	$0-$9,525	$0-$19,050	$0-$13,600	$0-$9,525
12%	$9,525-$38,700	$19,050-$77,400	$13,600-$51,800	$9,525-$38,700
22%	$38,700-$82,500	$77,400-$165,000	$51,800-$82,500	$38,700-$82,500
24%	$82,500-$157,500	$165,000-$315,000	$82,500-$157,500	$82,500-$157,500
32%	$157,500-$200,000	$315,000-$400,000	$157,500-$200,000	$157,500-$200,000
35%	$200,000-$500,000	$400,000-$600,000	$200,000-$500,000	$200,000-$300,000
37%	Over $500,000	Over $600,000	Over $500,000	Over $600,000

Data source: Joint Explanatory Statement of the Committee of Conference.

And, here are the previous 2018 tax brackets (which were announced by the IRS but will not go into effect):

Marginal Tax Rate	Single	Married Filing Jointly	Head of Household	Married Filing Separately
10%	$0-$9,525	$0-$19,050	$0-$13,600	$0-$9,525
15%	$9,525-$38,700	$19,050-$77,400	$13,600-$51,850	$9,525-$38,700
25%	$38,700-$93,700	$77,400-$156,150	$51,850-$133,850	$38,700-$78,075
28%	$93,700-$195,450	$156,150-$237,950	$133,850-$216,700	$78,075-$118,975
33%	$195,450-$424,950	$237,950-$424,950	$216,700-$424,950	$118,975-$212,475
35%	$424,950-$426,700	$424,950-$480,050	$424,950-$453,350	$212,475-$240,025
39.6%	Over $426,700	Over $480,050	Over $453,350	Over $240,025

Data source: IRS.

APPLYING SHORT TERM ANALYSIS

For example, let's say you're single and have taxable income of $50,000 per year. If you buy a piece of real estate and sell it a couple of months later for a $2,000 profit, you would have to pay tax at a rate of 25% under the previous tax brackets, while the new tax brackets give you a lower 22% marginal tax rate. This would result in tax savings on your short-term sale of $60.

BOTTOM LINE……………. A LOT OF THE SAME…… EXCHANGES ALIVE AND WELL

While nothing significant changed in the capital gains tax structure, or in the long-term capital gains tax rates, your 2018 short-term capital gains tax could change because of the new tax brackets. Generally, lower marginal tax rates and different income thresholds for most tax brackets combine to produce a potential short-term capital gains tax cut for many investors.

In a nutshell:

*********Capital gains tax is still with us

*********Brackets can have a slight impact

*********3.8% surcharge NOT repealed

*********Tax deferred exchanges for real estate alive and well

*********Can defer capital gains tax (both short term and long term)          

*********Exchange can eliminate 3.8% surcharge obligation

*********Personal property exchanges eliminated by new law.