Estate planning offers many ways to leave your inheritance to your children, but it’s just as important to know what not to do. Here are some common estate planning mistakes that you should avoid.
If you feel you have a good rapport with your family or don’t have many assets, you might be tempted simply to tell your children or loved ones how to handle your estate when you’re gone. However, even if your family members wanted to follow your directions, it may not be entirely up to them. Without a written document, any assets you own individually must go through probate, and “oral wills” have no weight in court. It would most likely be up to a judge and the your state’s intestate laws, not you or your desired heirs, to decide who gets what, and, if you’re unmarried, who will be guardian of your minor children. This is one strategy to not even try.
In lieu of setting up a trust, some people name their adult children as joint tenants on their properties. The appeal is that the children would be able to assume full ownership when parents pass on, while keeping the property out of probate. However, this does not mean that the property is safe: it doesn’t insulate the property from taxes or creditors, including your children’s creditors, if they run into financial difficulty. Their debt could even result in a forced sale of your property. It could also mean that if you later decide to sell the property, you may need to obtain their consent.
There’s another issue. Choosing this approach exposes you to otherwise avoidable capital gains taxes. Here’s why. When you sell certain assets, the government taxes you. But you can deduct your cost basis—a measure of how much you’ve invested in it—from the selling price. For example, if you and your spouse bought vacant land for $200,000 and later sell it for $315,000, you’d only need to pay capital gains taxes on $115,000 (the increase in value).
However, your heirs can get a break on these taxes. For instance, let’s say you die, and the fair market value of the land at that time was $300,000. Since you used a trust rather than joint tenancy, your spouse’s cost basis is now $300,000 (the basis for the heirs gets “stepped-up” to its value at your death). So, if she then sells the property for $315,000, she has to pay capital gains on only $15,000, which is the gain that happened after your death! However, with joint tenancy, she does not receive the full step-up in basis, meaning she’ll pay more capital gains taxes.
Giving Away the Inheritance Early
Some parents choose to give children their inheritance early – either outright or incrementally over time. But this strategy comes with several pitfalls. First, if you want to avoid filing a gift tax return and potentially hefty gift taxes, you are limited to giving each child $15,000 per year. You can give more, but you start to use up your gift tax exemption and must file a gift tax return, even though no tax will be due if you haven’t exceeded your lifetime exemption, at $11.4 million in 2019. Second, a smaller yearly amount might seem more like current expense money than the beginnings of your legacy, so they might spend it rather than invest. Third, if situations change that would have caused you to re-evaluate your allocations, it’s too late. You don’t want to be dependent on them giving the cash back if you need it for your own needs.
Shortcuts and ideas like these may look appealing on the surface, but they can actually do more harm than good. Use these tips to avoid some common estate planning mistakes. Consult with an estate planner to find better strategies to prepare for your and your families’ future. Call us to see how we can help.
Nielsen Law PLLC provides family focused estate planning to individuals and families in Austin, Round Rock, Cedar Park, and the Central Texas area. For more information and to learn about our firm, please contact us.