LLOYD MARTIN PLC

Introduction

There are at least three issues each of us should consider as part of our basic planning to ease the financial and emotional burdens associated with death and incapacity; (i) orderly disposition or transfer of property and care of minor children in the event of an untimely death; (ii) continuing business interests and managing financial affairs in the event of incapacity; and, (iii) assuring that one's directions and desires for receiving or withholding medical treatment are followed during a time of illness or following serious injury.

The orderly disposition of assets and designation of guardians for minor children may be done in a will; disposition of assets may also be done through a trust.  The uninterrupted management of financial affairs can be assured through a durable power of attorney.  Matters related to medical treatment may be addressed in an Advance Medical Directive, which may or may not include a living will.

Your Last Will & Testament

What is a Will?  A will is simply a legal document in which you provide for the distribution of your property after your death.  It names the persons who are to receive the various distributions from your estate, and the portions to be received by each.  Your will designates an administrator to take charge to see that its provisions are carried out as you stipulate, the guardian to care for your children and any trustee for any trust you create in your will.  A will can do lots of things!  It can provide for a lifetime income for a
loved one; guarantee a college education for a child; see that your favorite heirloom is given to your favorite niece; or, even provide a lifetime home for a pet!

Do you need a will?  You don't need a large estate to benefit from a will.  Wills are just as important to the person with a modest estate as they are to a wealthy patriarch.  If you have a family, or any relatives, you need a will.  If you own a home, car or just furniture, you need a will.  If you have bank accounts - if you own anything of value you need a will.  If you have minor children, you need a will to assure that you - and not the state - designate the person to act as guardian for those children in the event of your death. Suppose you don't have a will?  If you don't have a will, your property will be divided according to the laws of the state.

Some states (Virginia is one) have some unusual statutory descent and distribution rules (that's Legaleze for passing of property without a will).  Someone for whom you wish to provide may receive little or nothing!  Someone you don't even know could receive a large portion of your estate.  If you don't have a will, you cannot dictate exactly how your estate will be handled.  If you don't name an executor or personal representative, the court will appoint an administrator for you - someone you may not have chosen yourself.

If you don't have a will your estate  -  or the subsequent  estate  of one of your heirs  -  could suffer an unnecessary and large tax bite!  If you die without a will, the courts will, in effect, write one for you and there's no guarantee of proper care for those for whom you wish to provide.  Consider, for example, that under Virginia law, when a person dies without a will, all his or her property passes to the surviving spouse.  There is, however, an important exception to this rule:  If the deceased person is survived by children who are not also children of the surviving spouse (e.g., from an earlier marriage), then the surviving spouse receives only one-third of the estate and the other two-thirds pass in equal shares to the surviving children.

Only you can decide best how to distribute your estate.  Some things you will want to consider are the age, health, sex, legal rights and needs of each potential beneficiary.  Your lawyer can advise you on the best methods of distribution to save estate taxes and other expenses.

Who will care for your children?  Virginia law gives the last surviving parent the right to nominate a guardian of any surviving minor children.  This right is typically exercised in a person's will.  You may believe that there are many qualified persons on each side of your family to care for your children.  And you may believe that, rather than specifying one of them to serve as guardian of your children, it would be better to wait and allow the one who seems best situated at the time to step forward and request the court's
appointment as guardian of your children.

This is a risky approach because the first person who steps forward might not be the best person, or more than one person may step forward and the result might be a bitter fight to gain custody of your children.  Also, your children, who would have just experienced the traumatic loss of a parent, could be subjected to the additional trauma of a custody battle, or could be confronted with feelings of rejection because no one stepped forward immediately to serve as guardian.

You should decide who will care for your children - not the courts!  This is especially true if you are concerned about the parental philosophy, character values or religious environment in which your children would be raised if you are not around to care for them.

Do you need a lawyer?  A will is a very technical legal document and it should be prepared by a legal specialist.  So-called "do-it-yourself" wills have often been voided by the courts for minor legal mistakes.  You need a lawyer.  The cost depends on the length and complexity of your will.  Having a will is often less expensive than no will at all and, a carefully drawn will, can often reduce some of the taxes or expenses payable by your estate.  Simple wills will be prepared for you by many attorneys for as little  $100.00 - $300.00 - a small price for the peace of mind it will bring.

A word of caution - if you have any substantial amount of assets (investments, home, etc.) you probably need some estate planning assistance in conjunction with your will preparation.  A lawyer will also help you with this estate planning. 

Contents Of a Will

There is no single or standard form of a will.  Individuals differ, and their wills differ.  Most simple wills, however, tend to follow a common structure, with variations, additions and subtractions appropriate for the testator or testatrix in each case.  The most common structure begins with the testator's or testatrix's identity and domicile, followed by a revocation of all previous wills and codicils, a statement of funeral directions and disposition of remains.  Next come provisions for specific bequests and payment of debts, followed by an article disposing of tangible personal property and an article containing residuary legacies.

Residuary legacies are generally the most important part of the will, at least in terms of property isposition. Outright bequests may be made to a single legatee or property may be divided for a class of two or more legatees in various or equal proportions.  Also, all or part of the residuary estate may be "poured over" into existing trusts, or "testamentary" trusts, which could be created within the will itself.

The final article in most commonly used simple will designates the executor or personal representative to administer the will.  The more frequent variations on the common structure include addition of articles designating guardians for minor children, establishing trusts for children or care of elderly or disabled friends or relatives, charitable bequests or gifts, an articles granting or limiting powers to fiduciaries and containing survivorship provisions for common disasters.

In preparing for the making of a will, you must decide who you want to administer the will, the executor, who you wish to designate as the guardian for your minor children, and who you wish to act as the trustee for any trust created in the will.  It is a good idea to designate at least one alternate for each administrator, guardian or trustee, as well.  

You also should list the specific bequests you wish to make, and lay out the general distribution scheme you want followed for your assets.

If you plan to use a trust in your will, then you must decide on the terms and conditions under which you wish trust income and principal paid to beneficiaries and when, or the event, upon which you want the trust terminated.

For example, do you want your children to receive all the remaining assets in trust as soon as they reach the age of majority?  Or do you want the assets held until a later age or until each or all finish college?

A final point - don't try to make a will which you will never need to change.  Plan, of course, for a will that will last for at least a few years, but do not hesitate to change it as your circumstances change. 

Living Trust: A Will Alternative?

Many planners suggest the option of a revocable living trust as an alternative to a will.  Although a revocable living trust has many advantages, it is, at best, only a supplement to a will, not as a will alternative  and a living trust has its own problems.  Among the chief advantages as a will supplement is the avoidance of probate.  Assets held in trust do not become part of the probate estate of a decedent.  A trust is a separate legal entity that legally operates only through its trustees.  So when a beneficiary dies, a trust usually
continues to operate.  If the deceased beneficiary was also the trustee, then the trust continues to operate through its successor trustees.  Probate avoidance alone, especially in Virginia, is not a sufficient reason to use a living trust.  Virginia, unlike many other states, has a relatively simple and inexpensive probate process.

Competent legal advice should always be sought in the use of trusts.  Trusts which are provided at non-legal seminars or as part of off-the-shelf software packages could be fraught with pitfalls.

A Note for Business Owners

If you are a business owner, the continuation of your business in an orderly manner in the event of incapacity or death of either you or one of your co-owners must be considered.  In this regard, you need to plan for continued orderly operation of your business, asking such key questions as-

• Who will do your job or your co-owner's job if either dies or is hospitalized for an extended period?
• Will the financial condition of the business suffer in the event of an owner's prolonged absence?
• What will happen to your respective shares of the business in the event of the death of an owner?

While a durable power of attorney will generally allow your designated agent to manage your business affairs in the event of your incapacity, your designated representative may not have the technical competence to fill your shoes.  Also, in the event of the death of you or a co-owner of your business, are you or your co-owner prepared to become a partner with, or share control of the business with, the person who inherits the decedent's share of the business?

Business planning should usually, as a minimum, include properly drawn and funded buy-sell and illness-continuation agreements to cover the death and/or incapacity of the business owners.  If you are a business owner and have not properly planned for death or incapacity, you should not delay any longer.  Talk to your business adviser or attorney regarding these important matters.

A Comment for Real Estate Owners/Investors

A major area of concern for real estate owners and investors is the capital gains tax rates, the tax-free exclusion amount for estate and gift taxes, and the stepped-up basis for inherited property.

For most owners and investors, in 2016 (and until further notice), the tax rate on long-term capital gains is 15%, while those in the top bracket pay 20% and those in the 10% or 15% tax brackets pay 0%. Those earning more than $200,000 for single filers and more than $250,000 for joint filers may also have to pay a 3.8% "Net Investment Income Tax." Overall, that's rather low, historically speaking. Between the 1950s and the late 1970s, for example, the rates rose from about 20% to nearly 40%, and for a short period in the late 1980s, they were the same as the taxpayer's income tax rates, which could top 30%.

For estate and gift taxes, the tax-free exclusion for 2023 has risen to $12.92 million per person, with a tax rate of as much as 40% for amounts over $12.92 million; however, this amount is set to revert to the pre-2018 level of $5 million, adjusted for inflation, in 2026 when the Tax Cuts and Jobs Act (enacted in November 2017) expires.

An important aspect of the estate tax planning for taxpayers is that inherited real estate passes though the decedent's estate at a stepped-up basis. This means that even if the decedent has a low tax basis as a result of a purchase made years ago and/or acquiring the property as part of a 1031 exchange, the property will be inherited at a stepped-up basis, that is stepped-up to the market value at the date of death.

Real Estate and Capital Gains Taxes

The biggest tax concern when selling real property is capital gains tax. A capital gain is the difference between the “basis” in property and its selling price. The basis is usually the purchase price of property. So, if you purchased a house for $250,000 and sold it for $450,000, you would have $200,000 of gain ($450,000 - $250,000 = $200,000).

Couples who are married and file taxes jointly can sell their primary residence and exclude up to $500,000 of the gain from the sale from their gross income. Single individuals can exclude only $250,000. Surviving spouses get the full $500,000 exclusion if they sell their house within two years of the date of the spouse’s death, and if other ownership and use requirements have been met. The result is that widows or widowers who sell within two years may not have to pay any capital gains tax on the sale of the home.

Step-Up in Basis

When a real estate owner dies, the cost basis of the real property is "stepped up." This means the current value of the property becomes the basis. When a joint owner dies, half of the value of the property is stepped up. For example, suppose a husband and wife buy real estate they use as their primary resident, for $200,000, and then the husband dies when the property has a fair market value of $300,000. The new cost basis of the property for the wife will be $250,000 ($100,000 for the wife’s original 50 percent interest and $150,000 for the other half passed to her at the husband's death).

1031 Exchange Considerations

If one has acquired property in a 1031 exchange, he/she can continue over the years to defer capital gains, including depreciation recapture, by doing additional exchange(s), and then leave the property to heirs without any tax on the deferred capital gain.  The result would be that the exchanges over the years would, in fact, be income tax free. The heirs will not have to pay any income tax on the previous gain as they will receive the property with a tax basis at its current market value.

If the heirs sell immediately, they probably will not have any capital gain. If they hold the property, then only the capital gain and depreciation taken while they owned the property would be taxed when eventually sold-unless, of course, the heirs also did a 1031 exchange. The down side of this seemingly perfect way to beat "the tax man," is that if the decedent's estate exceeds the exclusion level (i.e., 2023 $12.92 million), then the excess will be subject to a hefty estate tax.

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We pride ourselves on the quality and excellence of our service to our customers and clients.  However, we are not perfect, so if we do not give you the service you expect, in both a timely and cost-effective manner, tell us.  We also believe that our competitive prices always give you value for your dollar.  Please tell us if you disagree!

LLOYD MARTIN PLC is a professional limited liability company.  Our practice emphasizes real estate closings, real estate law, and related matters.  The firm also provides legal services to small businesses and to clients in the areas of trusts and estates.  We bring to our clients and prospective clients over two decades of real estate experience in Northern Virginia.  We have also served the legal needs of our trust and estate and small business clients in the City of Alexandria and Arlington, Fairfax and Prince William Counties and surrounding areas since 1984.

The information contained herein is furnished by LLOYD MARTIN PLC for clients and prospective clients.  Readers should not attempt to solve legal problems based on information contained herein, it being of general interest only.