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I would like to understand the tax consequenses of having my mom put all of her assets into an Irrevocable Trust. The main reason would be planning for Medi-cal enrollment in the future as well as asset preservation.
Currently she owns two homes. One is a condo (bought in 2007) she lives in and will continue to live in. This home I have no questions about putting into an irrevocable trust and is not an issue.
The other is a home she has owned since 1967 and has been renting out for four years. She would like to sell the rental house in the near future and my sisters and I are not sure which way is the most advantageous tax wise. (She does not qualify for the capital gain exemption because it is not been her residence for 2 of the past 5 years. I think she gets a step up in basis based on my fatherís death in 2007)

1. She could not put it in the IT and then split the proceeds 3 ways after it sells and gift that money to us adult children.

2. She could not put the house in the IT and when it sells put the proceeds into the IT then split it 3 ways and gift it to us out of the IT.

3. She could not put the house in the IT and when it sells put the proceeds into the IT to remain there until she dies then distribute it.

4. She could put the house in the IT and then do any of the above.


When an IT is funded, are the assets being put into the trust by the creator of the trust considered to be gift to the trust and subject to gift tax?

Does an IT have a credit rating?

Thank you for any help. Wilma

Answer
Having been answering questions on this site for well over a decade and having been in my business for 3 decades, I have yet to find anyone that was ultimately happy using an irrevocable trust.

Irrevocable means: "Cannot Change" for the grantor or the beneficiaries. Cannot change how the assets are handled, cannot change how the income is handled, cannot change what will happen in the end. The trust must act only on the written instructions within the trust.  If any flexibility is left open, that flexibility is in the hands of a paid administrator.

If our economy was perfectly stable, we knew that real estate values would rise by 3% every year, that the cost to maintain the property would be exactly $X each year, that the rental market in that neighborhood was that every house remained rented, That the house wouldn't get any older, and would exist forever in its current state, and that inflation didn't exist, then it might be possible that someone could write a manual to manage that property, that would be relevant for more than 4 months.

But ours is not that perfect world.

Not only do you give up control for ever, you hand it over to someone that has a different set of allegiances. They want to make money. They don't have to care if you do.

You situation is complex, so I'm not going to claim to have a one sentence answer to solving the problem. I don't. There are better options than Irrevocable Trusts. But simply using revocable trusts and wills is not the best solution, nor is paying for a bunch of insurance.

Correct, correct, correct. The second house has lost the ability to provide a $250,000 gain exemption. It was stepped up, (only) if that paperwork was done correctly and new value was declared. Everything she owns is at risk if she goes into state managed long term care.

Your questions 1-4 can be handled without the IT. In all of those, the IT does nothing other than complicate it. There is no tax advantage, if the tax liability is passed back to the grantor, which is commonly the practice (since letting the IT be responsible for its own taxes would just result in significantly higher taxes.

The IT would have to have, MUST, require, the decision about when to sell, made at the inception of the trust, and memorialized in the body of the trust.  Otherwise it couldn't be sold, unless the verbiage of the trust allows the trustee to decide to sell it. Now if that is the only asset in the trust, the trustee would lose his job if sold, so would he want to sell? Later he might sell it when the value is just enough to pay all of his back fees.

You would also have to pay a disinterest third party trustee to manage the trust. And on a single rental property, that would probably wipe out any possible net rental income and start to deplete any equity.

So if the plan is to sell, then sell. If it is to keep it, then choose something else. Putting it into a trust removes the opportunity to plan later.

The basis would be stepped up again at her death and you kids could sell or keep the house without the IT.

So the problem that exists, really is the possible risk of long term care.

With or without the house that is a real concern. How you handle it needs to be considered. Some families would provide for her care within the family. In that case the house merely is a source of revenue to offset the costs. With or without an IT.

If the prospect of long term care is beyond the possibility of bringing her into someone's home then you have to consider the cost. If you intend to put it on the State from the beginning, then the State will choose their least cost option. Not necessarily her best service option.

The conventional way to overcome that is to pay for her long term care in a facility for at least 2.5 years. at this moment that seems to be the threshold where the State would continue her at the same facility regardless cost.

2.5 years of long term care is costly. Would that use up most or all of the house anyway? I don't know.

And the reality that Most people don't end up in the long term care category. All of these machinations and management expenses for nothing. There goes the value.

It is complicated.

I am not a big proponent of Insurance, as a solution and certainly not as a money maker. It can be a necessary evil in some cases, like auto insurance, maybe healthcare insurance, etc.

So if you are looking for a more business level solution. . . call me.

Richard
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Richard Fritzler

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Comparing the advantages and requirements of traditional estate practices, and unconventional methods? Are Trusts a viable asset protection vehicle? Is there an alternative to buying life insurance to reduce the impact of the estate tax. Is the elimination of the estate tax during the next decade good for everyone? I can review the benefits and misinformation that exists.

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I have been in the business of assisting business owners in reducing their taxes and liability for over 17 years. We specialize in developing plans that eliminate the estate tax, not find a way to prepay it. Most small businesses do not survive the death of the principal. We want small businesses to not only survive, but flourish.

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National Small Business Owners Association.
Nevada Association of Listed Resident Agents.
Citizens Legal Association

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Contributing author to "The Corporate Standard Newsletter".

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