The story of Mr. and Mrs. Smith
Mr. and Mrs. Smith have been clients of my firm for decades.
No, not that Mr. and Mrs. Smith. The couple in question are retired government workers and became my clients when their prior tax professional retired a few years back. Turns out they'd been talking with a friend who believes himself to be an expert in every single aspect of finance. His name is Peabody Knows Everything. Mr. Everything had offered the Smiths some unsought advice about estate planning and Mr. Smith had been very impressed by Mr. Everything's apparent knowledge of how such things work.
Right after they wed, the Smiths had begun investing in real estate. When they did retire, the four rental properties they'd acquired during their marriage were providing a tidy income every year. Now they were planning to retire to Florida and wouldn't be in the area to manage their real estate portfolio. They planned to hand over the property management tasks to their only child. Mr. Everything had heard about this and was giving the Smiths some tips on how to make the most of the situation.
"You should gift the properties to your son now, rather than letting him inherit them. That way, you'll get some really big tax advantages."
Mr. Smith wanted to follow Mr. Everything's advice immediately. Mrs. Smith, the wiser of the two by a wide margin, suggested they verify the existence of those tax advantages. So they came to talk this over with me, as her insistence.
I explained the difference between giving someone real estate and allowing them to inherit it. It's a big difference. Let's use just one of their four properties as an example.
The Smiths had purchased this home in 1985 for $100,000. It is now worth just under $1 million.
When you give someone a gift, their " basis" in the gift is whatever the giver's basis was on the day of the gift. The Smiths had paid $100,000 for it, so that was their original basis. But when you use property in a business, you recover the investment (cost) of that property over its useful life. This is known as depreciation. The useful life for depreciation purposes of residential real estate is 27.5 years. This meant that the Smiths' adjusted basis in the property is now zero. If they gave it to their only child, the child's basis would also be zero. Were he to then turn around and sell the property for $1 million, the entire sale price would be taxable.
On the other hand, if they were to allow their son to inherit the property, his basis in it would be whatever the fair market value of the property was on the day that the last member of the couple passed away. If that happened now, that's $1 million. If the son then sold it for $1 million, he would pay no income tax on that $1 million.
Now this is not a true story in terms of the people and property involved. But I did have a client come in recently who had been given some very bad tax advice by their financial advisor. I tell this story to illustrate that experts need to focus on those areas where they actually have the requisite expertise.
I don't give specific financial advise to my clients about investing. I'm not a certified financial planner or registered investment advisor. I will give some general knowledge advise about such things, like remembering to include age into the calculation of how much risk to take in investing. The older one gets, the less time there is to make up for the losses that come as part of making high-risk investments.
I am a big fan of people consulting with certified financial planners and other qualified investment advisors. But when it comes to the tax implications of moves and strategies suggested by such individuals, the best advise they can give their clients is to "check with your tax advisor before making any decisions."
No, not that Mr. and Mrs. Smith. The couple in question are retired government workers and became my clients when their prior tax professional retired a few years back. Turns out they'd been talking with a friend who believes himself to be an expert in every single aspect of finance. His name is Peabody Knows Everything. Mr. Everything had offered the Smiths some unsought advice about estate planning and Mr. Smith had been very impressed by Mr. Everything's apparent knowledge of how such things work.
Right after they wed, the Smiths had begun investing in real estate. When they did retire, the four rental properties they'd acquired during their marriage were providing a tidy income every year. Now they were planning to retire to Florida and wouldn't be in the area to manage their real estate portfolio. They planned to hand over the property management tasks to their only child. Mr. Everything had heard about this and was giving the Smiths some tips on how to make the most of the situation.
"You should gift the properties to your son now, rather than letting him inherit them. That way, you'll get some really big tax advantages."
Mr. Smith wanted to follow Mr. Everything's advice immediately. Mrs. Smith, the wiser of the two by a wide margin, suggested they verify the existence of those tax advantages. So they came to talk this over with me, as her insistence.
I explained the difference between giving someone real estate and allowing them to inherit it. It's a big difference. Let's use just one of their four properties as an example.
The Smiths had purchased this home in 1985 for $100,000. It is now worth just under $1 million.
When you give someone a gift, their " basis" in the gift is whatever the giver's basis was on the day of the gift. The Smiths had paid $100,000 for it, so that was their original basis. But when you use property in a business, you recover the investment (cost) of that property over its useful life. This is known as depreciation. The useful life for depreciation purposes of residential real estate is 27.5 years. This meant that the Smiths' adjusted basis in the property is now zero. If they gave it to their only child, the child's basis would also be zero. Were he to then turn around and sell the property for $1 million, the entire sale price would be taxable.
On the other hand, if they were to allow their son to inherit the property, his basis in it would be whatever the fair market value of the property was on the day that the last member of the couple passed away. If that happened now, that's $1 million. If the son then sold it for $1 million, he would pay no income tax on that $1 million.
Now this is not a true story in terms of the people and property involved. But I did have a client come in recently who had been given some very bad tax advice by their financial advisor. I tell this story to illustrate that experts need to focus on those areas where they actually have the requisite expertise.
I don't give specific financial advise to my clients about investing. I'm not a certified financial planner or registered investment advisor. I will give some general knowledge advise about such things, like remembering to include age into the calculation of how much risk to take in investing. The older one gets, the less time there is to make up for the losses that come as part of making high-risk investments.
I am a big fan of people consulting with certified financial planners and other qualified investment advisors. But when it comes to the tax implications of moves and strategies suggested by such individuals, the best advise they can give their clients is to "check with your tax advisor before making any decisions."
posted by me at 10:10 AM
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