Death and Taxes Blog

Previously (here), I have discussed the fact that not all claims against probate estates are created equally. Rather, under Illinois law, some claims have priority over others. For instance, attorney's fees, funeral expenses, and other administrative expenses get paid first (that is, they are first class claims). Most other claims are seventh class claims.

That being said, it's important to realize that secured property is not subject to the above classification system. As two commentators put it*,

Secured collateral that is in the possession of the representative is not a part of the probate estate and does not become a part of the probate estate until the secured lien has been discharged. Once the lien has been discharged, the formerly secured collateral becomes part of the probate estate and is available to other creditors of the estate.

To take an example: John Smith dies with a 200K house as his sole asset, a 100K mortgage on the house, and 200K in additional valid claims. His personal representative must pay off the mortgage first, and then use the remaining 100K equity in the house to satisfy the 200K in additional valid claims.

*See Richard A. Campbell and Mary C. Talarico, "Claims Against the Estate," Chapter 4 in Illinois Estate Administration (IICLE 2003).

This is a very nice article about the personal side of inheriting (or not inheriting) property, and the disputes that sometimes arise from the possibility of an inheritance.

I don't really have any answers here, but let me tell what I see on the ground with respect to probate estates. Obviously, there's a problem, just like there is with the rest of the economy. The main problem is (no surprise) with real estate and liquidity.

When an individual dies owning a house, the house is usually sold. In this market, that's a difficult proposition. That means the beneficiaries will have to figure out what to do with the house, starting with the payment of taxes and expenses. If Mom dies with a house valued at 200K, and a 100K mortgage, somebody is going to have to make the mortgage payments, keep the utilities turned on, and pay the real estate taxes. Is there money in the estate to do that? Often there isn't. Or, if there is money in the estate, there's not enough to make these payments for months on end.

The other thing about probate is that it takes some time to get going (I think a trust would be the same way, actually). If Mom dies, the beneficiaries grieve, and they try to find time to clean out the house, get things in order, etc. That means it can be 3+ months before someone says, "we need to figure out what to do with the house." Is renting an option? I suppose so, but most beneficiaries don't want to run a business, which is what renting property really is. Are you ready to interview renters, get a lease prepared, monitor the property, make sure repairs are made, etc.? Also, renting means that you really aren't planning to sell the property anytime soon (nobody wants to rent a house that's constantly being shown, or that they'll have to vacate upon sale).

One solution, although an imperfect one, is to rent out the house to a family member. This raises some issues of conflict of interest, but those can be dealt with, especially if all family members understand and agree. If you can find someone to help you break even (a renter willing to essentially pay the monthly mortgage, utilities, and taxes), it may make sense to take that offer.

Professor Beyer has a post (here) about why a bad economy is a boon for estate and gift planning.

The idea can be a fairly simple one. You believe stock in company X is undervalued, so you either give your shares in company X to someone (let's say your daughter), or you give your daughter money to buy shares. In either case, your daughter's buying power has increased because the market and company X's stock price have tanked. It's like the old broker's saying: "stocks are on sale." Hopefully, by the time your daughter needs the money, there will be a seller's market.

Let's take a more concrete example. You are convinced that GM is going to rebound. It's currently at $6.19 per share, and you think it will eventually (maybe in 5 years, maybe 10 or even 20) get back to $50.00 per share. You don't want to file gift tax returns, so you and your spouse decide to give your daughter shares of GM equal in value to your annual gift tax exclusion (currently $12,000 for each of you). That's 1938 shares each (or 3876 total shares). You make the gift, and GM goes to $50.00 per share. Your gift to your daughter is now worth $193,800!

Of course, the problem with making a gift like this in times like these is the psychology. It's already difficult for people to get over the idea that, if they make a gift, the gifted property is permanently gone. Add on the fact that many people feel like any current market conditions are somehow different than what we've seen in the past (this recession/depression will never end, house prices will always go up, etc.). The bold can make a lot of money at times like these, but are you really bold enough to act now?

I've posted a bit about the two major candidates for President, and their views on taxation. In the interest of providing a bit more information, I thought it might be helpful to see about the other four people who may appear on your ballot. Here's what their websites say on this issue:

Bob Barr (Libertarian Party)

Tax reform is desperately needed in the United States; but before we can reform the tax code, we must sharply reduce the tax burden on Americans. Meaningful tax reform begins with reining in government spending. Second, we need a tax code that makes taxation fairer and simpler for all citizens.

There are several alternative tax reform strategies. One would be to create a flat income tax, while cutting or eliminating many other levies, such as the estate tax (or “death tax”) and capital gains tax. Another option would be to replace the income tax and payroll taxes with a consumption tax, such as the Fair Tax

Ralph Nader (Independent)

Ralph Nader does not believe that "unearned income" (dividends, interest, capital gains) should be taxed lower than earned income, or work, inasmuch as one involves passive income, including inheritances and windfalls, while the latter involves active effort with a higher proportion of middle and lower income workers relying on and working each day, some under unsafe conditions, for these earnings.

Cynthia McKinney (Green Party) -- note that I couldn't find anything specific about estate tax on her website, but the Green Party's platform states the following:

The accumulation of individual wealth in the U.S. has reached grossly unbalanced proportions. It is clear that we cannot rely on the rich to regulate their profit-making excesses for the good of society through "trickle-down economics." We must take aggressive steps to restore a fair distribution of income. We support tax incentives for businesses that apply fair employee wage distribution standards, and income tax policies that restrict the accumulation of excessive individual wealth.

I would assume that's a vote to keep the estate tax.

Chuck Baldwin (Constitution Party) -- I also couldn't find anything specific on his website, but this is from the Constitution Party's platform:

[I]t is our intention to replace, with a tariff based revenue system supplemented by excise taxes, the current tax system of the U.S. government (including income taxes, payroll taxes, and estate taxes.)

If I missed any other candidates (Wiccan Party?), or if you have a link to more information about these candidates' views, please let me know.

It's always interesting when I'm facing the same situation in two different cases but from opposite perspectives. That's where I find myself with respect to the following issue:

beneficiary (child of X) has questions about the actions taken by executor (also child of X) before X's death, as an agent under X's power of attorney

The question is, to account or not to account? By which I mean, does the executor take the time to prepare an accounting of his or her actions as agent for the beneficiary? In Illinois, such an accounting is not required -- in order to obtain it, the beneficiary would have to file a citation action. But my preference, as an attorney trained in alternative dispute resolution, is to try to resolve court battles before they start. So, what's the harm in providing such an accounting, if it can actually allay the beneficiary's fears?

In my opinion there IS no harm, unless you are convinced that...

1. the beneficiary intends to start a court battle anyway; or

2. the beneficiary has acted unreasonably at other times, and you don't want to reward such behavior.

I guess these two points are related -- the executor has to make a cost/benefit analysis about whether it's worthwhile to provide the requested information. That means the beneficiary should strive to create an atmosphere in which there's a clear benefit offered to the executor for doing what is requested, and a clear detriment to NOT doing what's requested.

I just signed a lease on a second office, closer to home. It's located at 7225-27 West Madison Street in the hip, up-and-coming (though not because of me) suburb of Forest Park. Here is a map.

I still have my first office, located a bit further west in Westchester (One Westbrook Corporate Center, Suite 300).

Speaking of offices, I've had a number of questions over the past few months from new solo practitioners wondering how to set up an office. This is an important issue, especially with the current economy, where credit may be hard to obtain.

If you are hanging out your own shingle, you can do one of two things:

1. Go traditional -- get a big office, hire staff (secretary, paralegal), and take a big loan to finance all of this.

2. Do what I did, and in a sense continue to do -- operate in a low-budget way. I have only one employee, and he's a clerk who works on contract (only when I need him). I answer my own phones, and respond to my own e-mail. I use technology to keep in touch with clients, and I make myself flexible in terms of where I'll meet them (I make housecalls, although I'm trying to cut down on that). I get my business from referrals and, increasingly, from the internet. I have no debt.

So, you might ask, why do I have two offices? Well, office #1 is an office-sharing arrangement, through a company called HQ. For $200 per month, I get 8 hours of office time -- I typically use that to meet with one or two clients. If I need room for more than two clients, I rent out the office's conference room. HQ also has offices all over Chicago -- I can use these offices for a fee. (Am I sounding like an ad? I don't mean to. I'm sure HQ also has some competitors who presumably do a similar job for a similar price.)

I needed office #2 because (a) it was a great deal and (b) I need to get away from my family. I mean that in the best possible way, but my wife also occasionally works from home, and we find ourselves fighting over the fax machine and such. (There's also the issue of a high-spirited 7-year-old girl who loves to yell up to daddy in his office, even when daddy is on the phone.)

I guess what I'm trying to say is that technology has made it easier than ever for a savvy, debt-averse attorney to make it on his or her own. You aren't required to get a big office and a bunch of staff to make a go of it.

This Wall Street Journal article has it. I REALLY like the idea, endorsed by both candidates(!), of making the estate tax exemption portable. Let me explain a bit about what that means:

There is an estate tax exemption -- right now it's $2 million, but it's going up to $3.5 million next year and, possibly, down to $1 million in 2011. (Don't ask -- it's a frickin' nightmare.) Anywho, the idea is that you can leave up to the exemption amount at your death, and it's free from estate tax. So, if I have $1.5 million in assets when I die, there's no estate tax. The problem is that there's also an estate tax marital deduction -- essentially (and I'm simplifying here), nothing you leave your spouse is subject to the estate tax. And if you get the marital deduction for your entire estate, you aren't using your exemption. This is a "use it or lose it" concept -- under current law, your spouse doesn't inherit your exemption. It's gone for good.

To give an example: what if I have $2 million, leave it all to my wife (who also has $2 million), and she then dies? Under this scenario, I had a $2 million exemption that I didn't use, and my wife dies with a $4 million estate and owes estate tax. My exemption is lost forever, unless I've taken steps to do some estate planning to take advantage of it. This is usually done by setting up trusts upon the death of the first spouse (for the benefit of the survivor), which allows the survivor the use of the property of the first spouse without the loss of the exemption.

The idea of portability is (presumably) that the exemption of the first spouse would be added to that of the survivor, so there's no need to set up a living trust for estate tax purposes. (There are, of course, lots of non-estate tax-related reasons to do so.) Hopefully this change to the law will be made no matter who wins the White House -- I'm sure that literally billions of dollars are "wasted" each year on fixing this problem, and billions of dollars more are lost to estate tax because people DIDN'T fix the problem.

I recently received the e-mail from a reader, in response to some of my earlier posts about probate investors. I'm going to print it in its entirety, and then respond to a few points:

Having read several of your posts, I find many of your comments to be insightful and interesting. Although I agree with 90 to 95 percent of your comments, I disagree with a few of them in “Probate Investors Go Nutso!” and “Ads for Cremation Society of Illinois, J.G. Banks”. And I'd like to take a moment to present my rebuttal with an investor's slant.

First, I disagree with your supposition (in the prior post) that everyone “who attend seminars (like this one) and then try to launch careers buying real estate in probate for pennies on the dollar, flipping the real estate, and becoming rich.” You imply the idea of investing in real estate in probate would only appeal to someone who is already neither wealthy nor involved in real estate. I also find your comment to be somewhat biased and disingenuous: you imply the investor's motive to profit from investing in probate estates is ignoble; yet, you also profit from investing (your time and other resources) in probate estates--but your motive is noble. Real-estate flipping is a bona fide business. Most entrepreneurs start businesses to earn profits—not to go broke. Many—possibly most--attorneys, who practice law, don't practice for free; rather, they operate their businesses for profit—as do many consultants (myself included), physicians, auto mechanics, restauranteurs, etc. Businesses, that don't turn profits, don't remain in business for much longer. Thus, there's nothing inherently wrong with one trying earn a profit.

Second, technically, anyone who purchases anything in the US will make that purchase for pennies on the dollar—even if the purchase is at full price. From your statement, it appears you disapprove of the investors trying to purchase property at a discount (or wholesale prices). Investors aren't the only ones who purchase products and services from their suppliers at wholesale prices, add value, and resale the end products at retail prices (for a profit). Buy low, and sell high . . . and . . . profit on the buy, and realize it on the sale . . . these are two important mantras in business. Most manufacturers, physicians, educators, farmers, car-dealer owners, etc purchase at least a portion of their supplies at wholesale prices; and they sell their products/services at retail prices too. So, why single out the investor for trying to do the same? Note, it's usually the investor—not the others (realtors, contractors, attorneys, etc)—who puts his/her/their cash/credit on the line to acquire the property. The others--including the attorney(s)--usually get their money upfront and assume little or no risk; whereas, the investor usually assumes most—if not all—of the risk and gets paid on the back-end. Here, yet another mantra in business, called the risk/reward relationship, is at work: that investor assumes more risk upfront hoping to receive a greater reward on the back-end. Thus, there's nothing inherently wrong with one trying to earn a profit by buying low and selling high.

Third, most investors will gladly offer to pay a higher price for properties in better condition, because they have to spend less upfront to make it marketable. Since the market basically determines the sales price (a resistance) of a residential property, the only way for an investor to ensure that a rehab won't go over-budget is to offer a lower purchase price. (I'll elaborate later on how skilled investors determines their purchase price.) Continuing, you might wonder what kind of value does a real-estate investor add to a property. An investor adds value by doing the following: 1) buy properties that most retail buyers won't; 2) hire/manage several teams to rehabilitate, market, and sell a property (retail); 3) pay taxes (for properties that might otherwise remain abandoned); 4) work with the urban planners in various communities to help revitalize various neighborhoods by eliminating eyesores—which helps to preserve/improve property values—therein; etc. So, you see investors are a valuable member of the real-estate food-chain; they function primarily as facilitators, and they deserve to be paid for their contributions too. Thus, there's nothing inherently wrong with one trying to earn a profit while making positive contributions to various communities.

Of course, some might argue that the rehabs or new development could possibly gentrify a neighborhood—but that's another topic for another time.

Fourth, I disagree with your supposition (in the latter post) that investors will “purchase real property owned by probate estates at deep discounts, and then flip this property for a hefty profit.” You also mentioned later, that you rejected several offers from investors citing, “their offers (none exceeding $100,000 for a house valued at about $160,000) were simply unacceptable.” Although that discount typically includes a profit, that discount isn't the profit—rather it's the margin (sells price – cost). Those investors offered to purchase that property roughly at 62.5% (or less) of its market value (aka After Repair Value [ARV]). Based on your numbers, I suspect those investors expected to spend at least $50K-$55K on that property. Had you accepted the offer at $100K, that investor most likely would have received a profit of $5K-$10K (of that 37.5% [$60K] margin). The rest of that margin (aka the costs) would go towards fees: legal, document recording, banking, tax, environment tests, pest control, security, theft, weather-related expenses (flooding, down power lines, burst pipes, etc), appraisal, inspection, ALTA survey, marketing/sales, staging, title, insurance, cost of money (points, interest, draws, deposits, etc), utilities, licenses/permits, use changes, on-site property and project management, clean-up, trash removal (ie dumpster), accounting, and repairs (materials and labor). The ones foolish enough to purchase properties without a sufficient margin, will get burned in the end. I'm sure that anyone who's watched several episodes of “Flip This House”, will have seen several amateur (and a few pro) flippers come up short for that very reason. Thus, there's nothing inherently wrong with one trying to preserve one's profit by setting a reasonable operating margin.

Fifth, you state, “probate estates are not typically administered over a 10-year or 20-year period; instead, we're usually talking about 1 year or possibly 2 years of administration.” Although I agree executors typically don't administer them for 10 or 20 years, I also know the national average runs closer to 9-18 months if there are no will contests, and 2+ years otherwise—the duration is affected by the size and complexity of the estate, the number of will contests, taxes, etc. (I've verified this independently with several attorneys, circuit-court staff, bank mangers, and financial planners.) Typically, legal fees, taxes, mortgage payments, etc continue to accrue--and possibly compound or escalate--over that time (assuming the life insurance and other POD funds won't resolve the outstanding liabilities in the probate estate)—especially if the estate is large and complex. Additionally, your comment (later in that paragraph) about the notion of "the time value of money," presents an overly simplistic example, and fails to account for the fact that the probate judge (in many jurisdictions) usually has to approve the sale of any real property in the probate estate. What if that $160K property needed $50K of repairs (due to several problems caused by a faulty foundation [cause by flooding]), was refinanced 8 months ago for $160K at 7% 30-year fixed mortgage (monthly payments would be $1064.48), had 6 heirs squabbling over it for their “fair share” of that property (but who didn't want or couldn't afford to pay for any of the repairs)? I seriously doubt you'd sell that house in that condition to a well-informed, retail buyer for $160K. Besides, most conventional lenders—even during the real-estate boom—would not fund this deal at $160K. There are 2 reasons why a property won't sell: 1) the property is ugly, or 2) its price is ugly. That property in that condition is already upside-down (worth less than its mortgage), and would most likely become a short-sell candidate. Yet, even if that property were completely paid off instead, then the executor would still end up selling it for less than $160K due to the other issues. The point is, as long as that property remains a part of the estate, it will continue to decrease the value of the estate every month (due to its holding costs). Thus, there's nothing inherently wrong with one (an attorney, a funeral-home director, an investor, etc) trying to earn a profit and help someone else out of this kind of predicament.

Yet, I do feel it's wrong for one to prey upon the ignorance of others. It would be highly unethical—and criminal in some cases—to “tweak” the results of an appraisal. Besides, it's not like the seller couldn't also order an appraisal to validate the other results. An as-is appraisal will determine the value of the property in its current shape, and a subject-to appraisal will determine its value after XYZ repairs have been made. The point is that there are lots of checks and balances already in place to help prevent a potential buyer and seller from exploiting one another—at least in the residential market. Things are somewhat different for commercial real-estate, because both the buyers and sellers are considered to be more sophisticated. Nevertheless, most commercial buyers and sellers are capable of conducting a thorough due diligence on a property to ensure that neither party is trying to exploit the other party.

Anyway, investors aren't the enemy. Ignorance and knee-jerk reactions are the enemies. Actually, the consultant in me loved the way you summarized the steps “to find probate estates that may own real estate”; however, I'd reduce those three into a single step: collaborate/partner with with one or more probate attorneys--of course, they'll need to resolve any conflicts of interest beforehand. Provided the executor and probate attorney like/trust working with that investor, they all could agree to collaborate together on other projects in the future. For example, that investor (leveraging his/her/their network) could offer to help the executor to set up a Starker (or 1031) Exchange—which will enable the executor to legally defer payment on capital gains tax on his/her portion of the proceeds from sale of the property in probate—using the proceeds to purchase something like a cash-flowing, multi-unit, commercial property, and of course include the probate attorney in on the deal. Besides the tax savings, the executor and probate attorney will receive more tax savings (tax deductions due to depreciation [39 years for commercial properties]), higher ROI (more than they'd get saving that cash in the bank, or investing that cash in stocks/bonds/etc)--basically “Mo' money, mo' money, mo' money!” This creates a win-win situation for everybody, and that's only the tip of the iceberg.

A few points in response:

1. I don't think it's ignoble to make money in a probate situation -- that's obviously the line of work that I'm in, and for which I get paid. I don't begrudge anyone the right to earn a living. What I object to are sharp practices, where someone is trying to mislead an unsophisticated person into doing something stupid. And yes, this is partially the unsophisticated person's fault. (Sounds familiar, doesn't it? Person X is wrong for taking on a loan he can't afford, and lender Y is wrong for selling that loan to person X just to make a profit.) But, in the estate context, we're also talking about convincing someone to do something contrary to law (to violate a fiduciary duty). I can't get behind that (and, to be fair, neither can the writer).

2. Investors are free to try to buy real estate at wholesale prices. The problem is that, in many cases, they aren't in a wholesale market -- they're in a retail market. Someone making a 100K offer for a house with a fair market value of 160K is insulting the seller, and wasting the seller's time and his own.

Of course, there can be a disagreement between seller and potential buyer regarding fair market value -- real estate valuation is not an exact science. To take the example I mentioned in my J.G. Banks post: I was offered 100K for the house (which I thought was worth 170K), and the house eventually sold (3 months later) for 170K.

3. The reader is correct in saying that I shouldn't generalize about real estate investors. I will say that my interactions with them have been uniformly unsatisfying. That's not because the investors are greedy (EVERYONE is greedy), but because the ones I've met have shown themselves to be less than competent. They could've probably talked me down to 160K on the above property, done 30K or so of (mostly cosmetic) work, and flipped the property for maybe 225K. Instead, I get the ham-handed letter of interest ("so sorry for your loss..."), and then a laughably low-ball offer. I understand the risks that an investor is taking, but as a seller, those risks aren't my problem. I hope that, in the future, I will regular investors as well as all other potential buyers. But I will always insist on fair market value.

4. I disagree with this line: "the probate judge (in many jurisdictions) usually has to approve the sale of any real property in the probate estate." In Illinois, at least, I'd say that 95% or more estates are run in independent administration. That means a judge will OK anything and everything as long as the estate beneficiaries sign off on it.

On the McCain/Palin (or is it Palin/McCain?) side, there's some analysis of income tax returns:

Palin: Wall Street Journal article

McCain: Huffington Post article

On the Obama/Biden side, there's this open letter from prominent economists (including my current professor) who criticize Obama's tax plan. (Of course, there's some evidence, here, that lots of economists support Obama.) On Biden, I got nuthin -- are hair plugs deductible?

I don't know how I missed it, but Horton Foote's latest play is entitled "Dividing the Estate," and as the title suggests, it's about a fight over an inheritance. It's playing in New York City (details here).

Also, a movie that's probably a little less classy: Just Buried, starring Jay Baruchel of the wonderful TV series "Undeclared." The trailer is here -- a description:

After inheriting a funeral home in a small town where no one is dying, Oliver (Jay Baruchel) and his embalmer girlfriend (Rose Byrne) start bumping off townsfolk to drum up business.

And no, that description doesn't give me any ideas.

This is a sort of slimy story about William F. Buckley, his son Christopher (the author, about whom I've previously blogged), and Christopher's son Jonathan. Evidently Christopher cheated on his wife with a woman named Irina Woelfle, and she got pregnant. Christopher hasn't had much, if anything, to do with the son since his birth, although he does pay child support. Now Christopher's wealthy father has died, leaving language in his Will that explicitly disinherits Jonathan.

Is that fair? The article seems to think it isn't, although I would disagree. There seems to be a blurring of the lines between William's duty to a grandchild he may never see, and Christopher's duty to his son. We can believe that Christopher owes the child more (emotionally and financially) than $3,000 per month, but I don't have a problem with the disinheritance language in William's Will. Although it does sound a bit cold, especially if you read it in William's ridiculously affected voice. Maybe I should do an MP3 of my imitation?

For determining heirship in Illinois, it's important to understand the difference between step-relations and half-relations.

A step-sibling isn't really a sibling or a blood relation at all. It's the child of two people, one of whom then marries one of your parents.

A half-sibling IS a sibling. It's a person who shares only one parent in common with you.

Here's an example:

John and Peggy Smith have 3 children (Able, Betty, and Cody) when they divorce. John remarries, to a woman named Margaret Jones. Margaret has one child of her own (David) from a previous marriage. Together, John and Margaret have two children: Emil and Fred.

If Able dies without a Will, who are his heirs? Under Illinois law, it's his parents (John and Peggy), as well as his siblings. And because, under Illinois law (755 ILCS 5/2-1(h)), "[i]n no case is there any distinction between the kindred of the whole and the half blood," Betty, Cody, Emil, and Fred are also heirs. David is not an heir.

Can I tell you what I'm tired of right now? I'm tired of getting calls from old media folks -- Martindale, West, Thompson, what have you -- telling me that I should pay a bunch of money so that they can teach me how to compete on the internet. Let me tell you something, guys -- I'm already competing on the internet. I already get many, many GOOD clients as a result of my website and this blog. I don't need a bunch of huge corporations, who finally decided that they should figure out whether this web thing is going to stick around, calling me and acting like they are experts. They aren't.