Sometimes it pays to see a lawyer

The Chicago Tribune carries an advice column called "Housing Counsel" by Benny L. Kass.  Today's installment begins with this letter:

 My 80-year-old grandmother gave me a gift: her house. She often told friends and family she wanted me to have the house when she died. A couple of years ago, I was appointed guardian and conservator and quickly arranged to have a quitclaim deed put into my name. My grandmother died recently.

Many years ago, she paid $57,000 for the house. Today, it is worth over $800,000. I don't plan to live there, so I want to sell. I was told by a friend that since the house was a gift, when I sell it I will have to pay a lot of capital gains tax. Is this correct?

Kass correctly advises the writer that he or she has indeed assumed the giftor's basis, and that capital gains tax will be due on any profit (and further, that the basis can be increased by the cost of any capital improvements, with the additional possibility of a capital gains exclusion should the giftee decide to live in the house for two years).

What struck me, however, was the initial arrangement for a quitclaim deed, which seems to have been done without the help of a lawyer -- probably using a downloaded document, or perhaps a do-it-yourself service.  It is obvious that nobody advised the letter writer about the eventual tax consequences of an inter vivos gift, or of possible alternatives to the structure of the transaction.  I am neither a real estate nor tax expert, but I do know that an heir gets a stepped up basis at death.  I am guessing that the same result -- letter writer gets the house -- could have been obtained by the grandmother's  first gifting a life estate in the property, and then including a specific bequest of full title in her will, and thus no hefty capital gains hit.

So the letter writer saved a few hundred dollars in attorney's fees, but at the cost of over $100K in income tax.

Of course, there might have been another reason that the letter writer avoided seeing a lawyer, given that a large gift to a "guardian and conservator" is, shall we say, a bit questionable.  If there are other potential heirs in the picture, we may not have heard the last of this transaction.

If I have missed or misunderstood anything about the tax implications, it would be great to hear from some actual specialists.  But I doubt that anyone will think it was a good idea to prepare a quitclaim deed without the advice of counsel.

 UPDATE:  Clarification added above in response to a comment regarding who would get the life estate.

Comments

[Brian Frye]

Related scenario: piercing the veil claim, client "explains" that they saved money by not hiring a lawyer to create the subs. Pennywise, pound foolish.

[Anon]

Would that kind of deed you suggest, where grandmother retained a life estate but gave away a remainder immediately get the step up in basis under 1014? Isn't it a present transfer and thus not a transfer at death?

[Steve L.]

Sorry if I wasn't clear. I meant that the grandmother could have gifted a life estate to the letter writer (not the reverse), and then left title in her will. So the house itself would be transferred as a bequest with a stepped up basis.

Will add an update in the post.

[Kent Schenkel]

If the grandmother continued to live in the house after it was transferred then he should still get the step-up.

[Anon]

If the grandmother was incompetent, the guardian could not have written a will for her. He might, however, be able to execute a deed for her. Another thought, did the grandson do this to help make the grandmother eligible for Medicaid? If so, she couldn't retain any interest in the property.

[Kent Schenkel]

Also Steve, even if grandmother had gifted a remainder interest to the letter writer and retained a life estate he would get the full step-up at death.

[SL]

Thanks, Kent. It appears that there were several potential ways to effect the transfer without generating a huge capital gains bill, all of which could have been considered if the letter writer had been willing to pay a few hundred bucks for a competent lawyer.