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Beware Wealthy Relatives Bearing Gifts

I’ve discussed the pitfalls associated with relatives dying in New York bankruptcy and why bankruptcy for elderly debtors might be preferable to planning for their property going through probate after they die. There’s another route of transferring wealth between generations that can cause bankruptcy-related problems: gifts. It’s somewhat salient because the federal estate tax recently turned 100 years old.

Many older Americans own significant wealth that they would like to pass on to their children (or grandchildren, or other relatives, but I’ll just call them “children” here since that’s most common). Typically it’s the house they’re currently living in, but sometimes it’s stock shares, investment real estate, or other property.

One option elderly owners have is outright gifting these assets to their children. The problem with this approach is that donors don’t always complete the required forms notifying the IRS of gifts valued in excess of the per-recipient annual limit ($14,000 in 2015, doubled for spouses co-owning property). The lifetime estate-tax gift exemption is limited to $5.34 million, so any gift to an individual in excess of $14,000 is deducted against that number. This means that large gifts reduce the exemption on death for other property. Donors must track their large gifts over time.

Even if the lifetime estate-tax gift exemption isn’t an issue, say, for smaller estates, there’s also a capital-gains tax problem for gift recipients when they sell the property. The law requires them to pay tax on the profits of sale as though they purchased it at the price the donor paid. Had the parents not gifted them the property, i.e. it went through a will or probate, the income-tax amount would have been nothing. This can cause major problems for debtor-children hoping to pay down their own debts based on the sales of their parents’ property.

The second option for transferring large estates is co-ownership. In this circumstance, the parent adds the child onto the title documents for a home, bank account, or brokerage account. The benefit of this option is a smoother transition of the remaining ownership interest when the parent dies. On the other hand, adding a child exposes the parent to all kinds of liability. If the child files bankruptcy, receives a judgment against himself or herself for a tortious act, or creates new creditors for other reasons, the property’s ownership can be jeopardized. This is especially problematic for elderly parents who would face difficulties moving elsewhere.

A third option is also risky and less scrupulous; it applies to houses particularly. Sometimes parents will sell their homes to their children—occasionally for far less than the full value of the property—and then rent it back from them. The issue here is whether the IRS will consider such a transaction at arm’s length. This analysis is similar to that of preferences to insiders in bankruptcy. If the IRS deems the transaction not at arm’s length, the donor or the estate will be required to pay the tax for the difference between the market value and the sale value.

These rules don’t prevent parents from using the per-recipient gift rules to their advantage. For example, two parents could include up to $56,000 in a property sale to a child and his or her spouse as gifts. Any remaining amount between the sale price and the market value would be counted against the $5.34 million gift limit, but it can still cut down the sale price significantly.

The problem with selling or giving a home to a child is that they too can do what they wish with it, including reselling it or taking mortgages against it to pay creditors. Such things do happen, so it’s something to consider.

Transferring property to children can create serious tax consequences and even contribute to bankruptcies. Consequently, children should think twice before accepting unilateral gifts from wealthy relatives because sometimes there are better ways of transferring the underlying assets. If a property transfer has caused you significant debt problems, then you should discuss the situation with an experienced New York bankruptcy lawyer.

For answers to more questions about property transfers and bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced bankruptcy attorney in Brooklyn Bruce Weiner for a free initial consultation.

Rosenberg, Musso & Weiner, L.L.P
26 Court St # 2211
Brooklyn, NY 11242, USA

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