Yes, I Can Help Your Parents Transfer Their Home To You, But Let’s Talk First…

I’ve been practicing law for a while now, and there are some themes that come up over, and over, and over again.

One is that it is smart for Mom and Dad (or Mom or Dad) to transfer their home to the adult children while they’re still alive.  And when people believe this, I get calls or emails from people who want to know if I can help them to do it.  They are rarely prepared for the response I give them, which is “Yes, I can, but why do you want to do this?”

The answers are varied, but invariably, they boil down to 3 basic categories: (1) They want to avoid probate; (2) They think that this helps to prepare the parents for long-term care or Medicaid planning; (3)  They can’t really say why.

This is when I get to tell the people asking me this question the following:

First, here in the state of Washington, probate generally is not something to be feared.  What I tell people about the process is “If we don’t have an estate tax problem, we don’t have odd assets which we have to try to value or dispose of, and, most importantly, if everyone is playing nice, then the process can frequently be wrapped up in 6 to 8 months, for a moderate cost.  In addition, going through the probate process provides certainty for the heirs and beneficiaries that all the claims and potential claims against the estate are dealt with, so no one shows up a year later with their hand out.  Finally, the appointment process by which the Court identifies and empowers a person to deal with the estate often eliminates struggles over how to proceed.

Second, transferring the house to kids is a transfer of an asset that will count for purposes of computing eligibility for Medicaid benefits, and if Medicaid or long term benefits are necessary within 5 years of making this transfer, you may have just made Mom or Dad ineligible for receiving that assistance for a period of time that can be as short as months and as long as years.  So instead of helping Mom and Dad, you could be harming them, but this is a question of timing, and it could be part of long term planning provided it is considered long before Mom or Dad need long term care.

Third, people rarely understand that there are tax consequences for making these kinds of transfers, for both Mom and Dad, and for the kids.

For Mom and Dad, they need to make sure they cite the correct exemption to avoid state excise tax on the transfer.  Because the value of the home is almost always more than annual federal gift tax exemptions, they should also be filing a federal gift tax return.  Because the amount of the lifetime federal gift tax exemption amounts available to each citizen is currently in excess of five million dollars, most of the time, Mom and Dad should be able to apply available exemption amounts to the gift, unless they have already used up their exemption on prior gifts.

For the children, accepting this gift made during Mom and Dad’s lifetime (an inter vivos gift) means that they don’t get a stepped-up basis in the property that they would get by inheriting it instead.  If they inherit the property, the kids get a basis in the property equal to the value at the time Mom or Dad passed away.  This minimizes or eliminates capital gains if the kids were to sell the property shortly after.  However, taking the property as an inter vivos gift means that they get what is often a much lower basis in the property, making capital gains on the sale a much greater possibility.

Inter vivos gifts of a parent’s home to the children can be a useful part of an integrated and well-thought out estate plan, but it is not a transaction that should be engaged in lightly, or without serious consideration.

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A New Year Brings New Opportunities

Estate Planning isn’t a “one and done” process.

It would be easy to respond to this assertion by saying “You’re just trying to stay busy.”, and you’d be right, but the fact is that people’s circumstances will change, and often do.  If their estate plans don’t reflect these changes in circumstance, it can sometimes cost their estates far more than it would if they had spent a little money and time making the necessary changes.  The nature of these circumstances will dictate how often people should review and make changes to their estate planning.

Clients of modest means generally don’t have to make frequent changes to their estate plans for financial or tax planning purposes, and this has been the case for a while now with federal estate tax thresholds that have been quite high in comparison to the average person’s estate.  When I recommend changes to clients in this financial category, it usually is due to the fact that a considerable amount of time has passed since their existing Wills and other documents were prepared, and now children are no longer minors in need of guardians, and designated personal representatives and alternate beneficiaries have passed away, or the principal has since divorced and remarried, which may or may not call for something a bit more complicated than what they previously had, depending on their goals and objectives.  These are generally people who may have executed estate plans ten or more years ago, and may alter them once or twice throughout their lifetime, to acknowledge kids becoming adults, persons nominated in various capacities getting older or passing away, or changes in the value of their own estates due to inheritances from other family members.  I may recommend changes to durable and medical powers of attorney more frequently than I will for changes to Wills for many of these people, because entities who rely on these documents (banks, hospitals, brokerage houses) seem to constantly be increasing specific delegations of authority, despite the fact that the enabling statutes contemplate broad, general grants of authority.

For people who have more substantial wealth, I recommend reviewing your estate plans much more frequently, as their wealth tends to compound and accumulate much faster, often putting them in a position of needing to have integrated estate and tax plans in order to avoid unnecessary taxes at the time of death.  This means weighing various options, as complexity can go up, and direct control goes down when utilizing tax mitigation strategies.  These are conversations that need to include accountants, as well as the attorney, because mistakes can be costly, and integration is important.

In closing, change comes to every life.  Sometimes the changes are big.  Sometimes they are small, but they are cumulative.  Births, deaths, divorces, inheritances, windfalls, “the magic of compounding”, and divorces are all changes which should prompt you to make an appointment with your attorney to discuss whether or not you should change your estate plans, and if so, to what degree.   Is it a simple codicil to your Will, or is it starting all over and  adding trust provisions?  Attorneys, and sometimes accountants, can help you answer these questions, and maybe help you save a considerable sum of money and heartache for your loved ones.

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I Can’t Say It Enough…

…good estate planning requires advice from more than one discipline.

I was talking this morning with a friend of mine who is an estate planner.  I haven’t known him for a long time, but I like his approach, and I think it differentiates him from other financial planners I’ve known, because he’s got a passion that you can’t really fake, and it is clearly about doing the right thing for the client.  In this case, it means that he spends a considerable amount of time helping clients protect what they already have before he talks to them about using the wealth they have to accumulate more to fund whatever their end goal is.

I’ve been doing this long enough to understand that not everyone is wealthy, but I think that most people want to build what wealth they have.  Sure, some people have come to see me about their estate planning because they have gotten the bad news from a doctor, and that distant inevitability is now an impending certainty.  A holistic approach is probably not foremost in their minds, but an awful lot of people I’ve represented have more wealth than they think they do, and when we sort that out as part of the process, it often requires consulting with other professionals.  Granted, if we’re doing the estate planning because someone has stage four cancer, then we aren’t likely to be talking with them about life insurance, but we might be talking with them about brokerage accounts, 401(k)s, individual retirement accounts, and their interests in closely-held corporations and LLCs, which means that we will be talking  about transfer-on-death or payable-on-death designations on accounts, and how those designations can impact their estates, which means that we will be talking with their financial planners.  We will be talking about potential tax consequences for various potential courses of action, which means that we will be talking with CPA’s and accountants.  And sometimes, I even end up talking to representatives of charities about gifts that clients want to make.  When I am doing this for the clients who know that they aren’t long for this world, I’m not just sad for the client’s approaching demise.  I’m sad for the opportunities that they lost by not acting sooner.  Sometimes, this is because of procrastination, and sometimes, it’s because people don’t understand that estate planning shouldn’t be a mass of disjointed pieces, but a comprehensive plan, focused on the goals they rate as most important, and executed with a series of coordinated steps which have been considered and mapped out with the assistance of a team of professionals who want to help them succeed.  Once I help clients to fully understand this approach, I don’t often end up having  conversations about cost, because they understand that compared to the return they can achieve, the cost is minimal.

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The Bad News Is…

One of the things that law school didn’t really prepare me for was the clients who you can’t help.

When I first started practicing law, I was eager to help clients and potential clients, and there was one who stands out in my memory as the first one I couldn’t help.  He had cosigned on a car for a relative, who had defaulted, and he came to see me, because the bank had come calling on him.  I saw nothing in the documents or the circumstance he described that would permit me to be of any meaningful assistance, but I was slightly worried that he might try to hurt me after I told him that I couldn’t help him.

He was very deliberate as he pushed back from the table, and left the room, never saying a word, and his jaw set like a rock.  After my initial relief at not having to dodge a punch or three wore off, I recall thinking “Well, that’s one person whom I’ll never see again.”

But I was wrong.

Before I moved on from that firm, the man came back to see me two more times.  The next time I met with him, he had a contract he wanted me to review before he would decide whether or not to sign it.  I was delighted that he consulted with me first.  I read through the document, noted a few points that I though he should be aware of, which prompted him to tell me that he was going to think about it before deciding to sign or not.  After wrapping up my notes, I looked up and said “Can I ask you something?”

He smiled and said “Let me guess.  You want to know why I came back.”

I nodded my head and said “Yes.  I could tell you were pretty upset when you left last time.”

He laughed and said “You’re not wrong, but I will tell you that I wasn’t upset with YOU.  In fact, I liked the way that you didn’t sugar coat it, even though you didn’t like telling me that there was nothing you could do.  You were honest with me, you didn’t waste my time, and you told me what I did wrong without making me feel stupid.  I knew I had found someone I could trust, and that makes you worth the money you charge.”

I saw him one more time, when I wrote a Will and powers of attorney for him.  Again, he expressed his thanks for the straightforward advice, and the no-nonsense approach.  I still think of him often, because I still encounter people whom I can’t help.  I won’t say that it’s easier telling clients this now than it was then, but I find that by trying to be respectful of their time, and by trying to not make them feel stupid because they made a mistake, I give them something of value, even if it was only allowing them to leave with the dignity they had when they walked in to my office.  Not everyone reacts well to such news, but I have managed to keep a few of them as clients because I approached their problems in this manner, which turns a negative into a much larger positive.

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Commercial Leases: The Devil Really IS In the Details

I’ve often heard other lawyers talk about how lawyers have a sickness.  I’m not sure that I would characterize what makes attorneys different as a sickness, but I will admit that we often seem weird to non-lawyers, and that this weirdness manifests itself in mundane ways.  My most obvious manifestation involves commercial leases.  How so?  Because I actually enjoy reading through them.  In fact, I’ve admitted publicly that being handed a commercial lease to review is like “Where’s Waldo?” for me.  I get out a pencil and my notepad, and I go to work.

Being a “country lawyer”, I don’t get to review the super-complicated, hundred-page plus leases that some attorneys get to build their careers around, but it isn’t unusual for me to be handed a commercial lease which is 30 to 50 pages long, and I have drafted some of similar length for clients.  The key is understanding that it really does take that many pages to include the “boilerplate” that you should expect in every commercial lease.  The problem is that I often discover that everyone takes the boilerplate for granted, and no one bothers to read through it carefully and determine if it makes sense for the individual tenant.  Hazardous materials clauses are a staple of commercial leases, and with good reason.  Environmental cleanup costs are very expensive, many owners policies limit the  but too often, landlords fail to think through the effect of whatever language is in their boilerplate, and the clients either don’t read carefully enough to know if they have a problem.  Many clauses broadly define “hazardous materials”, and if the lease does not narrow the definition, or make exceptions for materials commonly used by certain businesses, then a landlord may put a tenant in a position where the tenant is in violation of the lease from the moment they commence operations.  Perhaps the most obvious example came when I was asked to review a lease for a nail salon.  The hazardous materials clause was broadly written, and the tenant was shocked when I informed them that since they use acetone, they would technically be violating the lease.  In that case, the landlord was just as shocked as the tenant, and was willing to include an exception for acetone, and some other products that the salon used.  This is why patience in reviewing, along with careful note taking can help a tenant avoid nasty surprises like this which may be lurking in plain sight.

I also spend a fair amount of time with commercial leases looking at issues regarding Certificates of Estoppel.  Put simply, a Certificate of Estoppel is a certification by the tenant to a third party of certain facts regarding the lease.  The facts usually involve the length of the lease, whether or not either party is in default, the amount of the rent, or whether the tenant is currently insured as is required by the lease.  It is a subject that should not be an issue, but it frequently is, because landlords, or their banks will often ask tenants to certify things which aren’t true, or do not comport with the lease, which would have the effect of rewriting the lease moving forward, and maybe eliminating any remedy for violations or duties owed by the landlord which the tenant would otherwise be entitled to demand.  Another common error with Certificates of Estoppel occurs when the lease specifically limits what the tenant may be asked to certify, but the landlord (or a creditor of the landlord) asks the tenant to certify something outside of the specific scope defined in the lease.  This frequently occurs when a bank  or other lender has taken over possession of a property, and seeks to rewrite certain lease terms.  I no longer think that these occurrences are accidental.  I’ve spent too much time talking to representatives of banks or other lenders who clearly have a copy of the lease in front of them, and yet they ask, or more often demand, that the tenant certify something outside of the scope limited by the lease, or that otherwise is different than what the lease requires.

Finally, insurance clauses, in concert with indemnity and hold harmless provisions, require specific diligence in review. Many commercial transactions involve burden shifting, and the party with more bargaining power will shift as much liability or potential liability as they can to the party with less power.  This isn’t unusual, and I expect that, but every now and again, I get a lease where someone has gone overboard, and requires the tenant to accept certain liabilities which may or may not cause them to violate provisions of their insurance policies, or even void their insurance policies, which would leave the tenant legally liable and without any recourse against their own insurers for any recovery or contribution.   This is a problem when it involves a small business that doesn’t expect to make a lot of money,because they will often have NO bargaining power to change this, and don’t want to spend any money to even properly understand what it means for them.  But when I’m dealing with larger companies, I will sometimes arrange to sit down with the client and their insurance agent to discuss the specific wording of these clauses, and let the client hear directly from their own agent why the wording of these clauses will create problems with their coverage if it is not changed, and we will make detailed counter-proposals for alternate clauses which won’t leave them bare in the face of potential liability.

These kinds of pitfalls are why if you are looking at signing a commercial lease, it makes sense to hire an lawyer with my particular brand of weirdness to spend a few hours reviewing the lease, and then going through it with you.  Yes, it requires an outlay of capital, but it doesn’t cost as much as voiding your insurance coverage or rewriting a lease to the benefit of your landlord’s creditors.

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The Importance of Agreements Between Business Owners

So you and a friend have taken that leap and decided to set up a business together.

Great! And Congratulations!

But the lawyer in me has to ask “Do you have your exit plan in place?”

I see the look of shock on your face.  It could only be more genuine if I slapped you.

“Weren’t you listening?  We just started the business.  I’m working with my best friend and we’re going to make piles of cash!”

I heard you.  And I’m genuinely happy for you.  I HOPE you succeed.  No attorney wants his clients to fail.

BUT…

I can’t tell you how many times I have witnessed a business start with all the hope and potential you’d expect in a new venture, only to see the owners get in knockdown dragouts which end up destroying the business when conflicts come.  The fact is that you will probably need an agreement between the owners at some point anyway, either for tax purposes, or for the ability to obtain loans from banks, or for some other  legitimate business purpose.  However, the way I talk to clients about it is to tell them that this is their opportunity to “pre-negotiate” a divorce, and the best time to do that, the time when everyone is most likely to be fair with each other, rather than consumed with emotions that often cause people to make  bad decisions, is when everyone is happy and excited.

I know, some you might think that this would be the last thing that business owners would want to be thinking about at a time like this, but putting aside issues of fairness, it is also when people are going to be the most objective when considering issues such as what happens if an owner becomes disabled, or dies.  Do you want to be a partner with the surviving spouse?  Do you want to be a partner with the children or other heirs?  If you don’t, how do you want the estate fairly compensated for this? How will you value that ownership interest?  Do you want restrictions on the transfer of ownership?  What happens if an owner transfers their ownership interest WITHOUT consulting the other owners or complying with transfer restrictions?  What if an owner simply decides that they want out?

Being able to agree ahead of time to the answers  to these and a host of other questions is important, because if you don’t agree, then you get to get attorneys and courts involved, and the issues will be resolved, but it will take a lot of time, money, irritation, money, effort, and money, and by the time you’re done, the business may not survive, and you might have some significant legal costs as well.

The good news is that you have a choice, and you can make decisions right now that will make that day considerably easier to deal with.  It may even make it possible to keep the friendship, let alone the business, and there isn’t really a price that can be put on this.

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Incongruities

Pencil

Yesterday morning, as I was getting dressed and thinking about my slate of meetings for the day, I decided to put a pencil in my pocket along with a pen. Normally, I wouldn’t devote any thought to this action, but as I picked up the very beautiful Parker Duofold I inherited from my father, I paused, and reflected on the significance of it.

My father was a science teacher by trade, and you might think that being a teacher, he wouldn’t have any ambivalence towards the humble pencil, which allows the holder to convey thoughts to paper, and to refine those thoughts through judicious use of the eraser. However, even my earliest memories of him helping me with my homework contain various echos of him complaining about my use of a pencil. When I grew older, I think when I was in junior high school, I asked him why he didn’t like using pencils. His response was typical for my father, who was a man of few words:

“Because the very act of using a pencil implies that you will make a mistake.”

Even then, I appreciated the brevity and confidence embodied in that simple sentence, but I didn’t share the sentiment. I could say that it was my own contrary nature, which is a trait which I can directly attribute to both him, and the paternal line of my family, and while it would be partially true, the more honest answer was that I reserved brash confidence for the things I was absolutely sure of, and my experience in school was that I still made mistakes.

As I grew older, and my education progressed, my confidence and skill both appreciated, but I never lost my affinity for the humble pencil. I used them for tests. I used them in drafting class. I used them in band. I used them when I wrote papers. And I used the eraser, right alongside, even if I used it less frequently as time wore on, without giving a serious thought as to why I did so. It wasn’t ever in the forefront of my mind until one of my first classes in law school when a professor made it clear to me why I still used a pencil, even as I rapidly and efficiently scrawled lecture notes in ink in pages of the notebook before me. He waited until everyone was seated and quiet, and like a performer, realizing he had the complete attention of his audience, he reached into his pocket, and pulled out a yellow No. 2 pencil, and held it above his head so that everyone could see it clearly. Without stopping to clear his throat, he announced to the quiet lecture hall “As attorneys, we think with these.”

To be completely candid, I couldn’t tell you what he said after that, because I was still absorbing his statement, and considering its implication. Suddenly, it became clear to me. I didn’t use pencils because I expected to make mistakes; I used pencils because any initial thoughts committed to paper can always be refined and improved upon.

And this, more than anything else, is why I still use pencils.  Even now, when surrounded by the ubiquity of desktop computers, laptops, tablets, and smart phones, I often use pencils to make initial thoughts better.  Pixels are nice, and the delete and backspace buttons work as well as any eraser, without need for replacement, or pesky soiled shavings, but they don’t have the same sense of timelessness, or feeling of gravitas that handwritten words, pressed into paper, seem to carry.  A pencil is portable.  It never needs to be plugged in.  A virus can’t wipe out what you’ve written with a pencil.  Malware cannot hold its work product hostage.  I can use a pencil anywhere.  I refine phrases and words, and increase clarity. I can use a pencil to distill ideas their bare essence. And I relish the promise and potential of a blank notepad and a pencil, as the anticipation of what might flow out of my mind and on to that paper builds slowly in my stomach and the small of my back.

I reflected on this journey of realization, as I regarded the beautiful mechanical pencil in my fingers, and then the question occurred to me: How is it that a man who rejected the implication implicit in the use of a pencil came to own such an ornate one?

I pondered it for a few moments, as my eyes drank in the sheen of the mother-of-pearl body, and the shine of the brass cap, which is engraved with his initials, KLW. And then it occurred to me. The eraser was under the cap, which is not at all easy to remove. It isn’t a writing utensil that you would use if you anticipated making mistakes.

Well played, Dad. Well played.

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