Louisiana Usufruct

Do Usufruct Account Investments Get Taxed When Naked Owners Receive Them?

I'm occasionally asked whether heirs or naked owners are subject to tax when they receive the proceeds or investments from a usufruct account.

To explain this easily, let use an example: Husband dies while Husband and Wife own a $2 million investment account. The account is community property. Husband's Last Will leaves the lifetime usufruct of his estate to Wife. Husband's children are designated in the Last Will as the naked owners.

Husband died. Wife and naked owners get together, hire lawyers, complete the Succession, judge signs necessary court orders, financial institution's lawyers review the court orders, and the $2 million joint account gets divided into two new account: one solely in the name of Wife (her half of the community property), and another account titled, "Wife Usufruct." Years later, after interest, dividends, sales, reinvestments, market appreciation and depreciation, Wife dies and assets are distributed to the naked owners. The naked owners are wondering whether tax is due.

There really should be two questions asked: (1) Do we owe tax? and (2) Are we receiving the right assets?

Unless Husband's estate was large and exceeded the estate tax exemption when he died - requiring an estate tax marital deduction election, the usufruct assets will not be included in Wife's estate for federal estate tax purposes. So, typically no estate tax due.

Income tax not likely to be applicable under the general rule that an inheritance is free of income tax. Note that beneficiaries of traditional IRAs and certain annuity beneficiaries have income tax consequences upon distribution of those accounts, but that is beyond this scope.

The real messy one is the capital gains tax. It's messy because usufruct accounts are often not established consistently with Louisiana usufruct law.

Here'a a few rules that are helpful. Interest and dividends produced by assets subject to usufruct belong to the usufructuary. If stock in the usufruct account pays a dividend, that dividend should go into Wife's individual account. This is important because Wife's heirs may be different than Husband's naked owners. Also Wife's assets in her estate get another step-up in basis when she dies. While assets subject to usufruct typically do not.

Another important rule all usufructuaries and naked owners to know is that when investments (nonconsumables) subject to usufruct are sold, the usufruct attaches to the proceeds of the sale (money, which is a consumable), and Wife becomes the owner of the money with an obligation to pay the naked owner this amount when the usufruct terminates.

Another example: Wife, as usufructuary. sells investments in the usufruct account for $500,000. There may be capital gains tax due if these investments had appreciated since Husband died. Nonetheless, Wife reinvests these proceeds and, at her death, they are valued at $800,000. Result: Wife's heirs benefit from this appreciation. Wife's heirs enjoy the benefit of another step-up in basis when Wife dies, and Wife's estate owes Husband's naked owners $500,000.

Bottom line: If assets subject to usufruct are sold, then when the usufruct terminates and the naked owners receive the assets and sell them, they will owe capital gains tax on the appreciation that occurred since the date of death of the person who bequeathed naked ownership to them.

There are many moving parts to usufruct and naked ownership taxation, ownership, and indebtedness that affect the rights and obligations of usufructuaries and naked owners. And since sharing an inheritance is not always the most amicable of life circumstances, it would behoove you to have an understanding of these difficult-to-understand concepts.

This post is for informational purposes only and does not provide legal advice. Please do not act or refrain from acting based on anything you read on this site. Using this site or communicating with Rabalais Estate Planning, LLC, through this site does not form an attorney/client relationship.

Paul Rabalais

Louisiana Estate Planning Attorney

www.RabalaisEstatePlanning.com

Phone: (225) 329-2450

Estate Planning Case Study: Married Couple with $3m Estate

While every individual and couple that engages in estate planning has a different set of circumstances - no two are the same, the following is a case study of a Louisiana couple that has accumulated some wealth, never engaged in estate planning before, has two adult children who are late 20's and early 30s, and wants to keep control of their estate, provide for the surviving spouse, preserve it for the kids, keep estate matters simple, and avoid tax and government interference.

Let's say that the couple owns a home in Louisiana and a condo on the beach in another state. The husband worked for a chemical company, built up his 401(k), and when he retired, he rolled over his 401(k) into his traditional IRA. They have a joint brokerage account, vehicles, and a boat. Total estate is $3,000,000.

Some of the issues we would discuss include:

(1) First Spouse Dies. We would discuss how they want to leave their estate to their spouse when the first spouse dies. Do they want to leave their estate in full ownership to their spouse? Do they want to leave their estate in trust for their spouse so that assets get preserved for the children after the surviving spouse dies? Or, since they live in Louisiana, do they want to leave usufruct to their spouse, giving their spouse an obligation to account to the kids at the termination of the usufruct? Each of these options has varied estate tax, income tax, and capital gains tax consequences. Gotta do this right the first time before the first spouse dies.

(2) Surviving Spouse Dies. Do they want to leave assets to their children outright or in trust? Do any children have special needs, the inability to handle a lump sum inheritance, marital issues, or some other issues that would warrant leaving the inheritance to a child in trust? Lots to discuss here.

(3) Who's In Charge When You Can't? Who should be primary and backup for Trustee, Executor, Durable Power of Attorney, Health Care Power of Attorney, etc. We'd discuss the life-support machines decision.

(4) Taxes. We discuss the distribution rules for IRAs and retirement accounts and how those rules differ for spouse and non-spouses as beneficiaries. We'd discuss the step-up and double step-up in basis which can save the heirs a fortune when the sell your assets.

(5) Avoid Probate. We'd discuss the pros and cons of the "Will Based Plan" and the "Revocable Living Trust Based Plan," which can allow the surviving spouse and the children to avoid multiple probates in multiple states - given that the couple owns real estate in two states. The RLT Program would keep brokerage accounts from being frozen in the future.

Again, since very person is different - their objectives, their family, what they own, don't take this info and think that it perfectly applies to you. You need to work with the right estate planning attorney the first time so that problems don't surface later.

This post is for informational purposes only and does not provide legal advice. Please do not act or refrain from acting based on anything you read on this site. Using this site or communicating with Rabalais Estate Planning, LLC, through this site does not form an attorney/client relationship.

Paul Rabalais
Louisiana Estate Planning Attorney
www.RabalaisEstatePlanning.com
Phone: (225) 329-2450

Children Donate Naked Ownership Interest Back To Surviving Parent

I've been working with a family recently. Dad passed away without a last will and testament ("intestate"). I explained to the family that since Dad died intestate, Dad's half of the community property would be inherited by Dad's children, subject to Mom's usufruct.

The children wanted to support Mom both emotionally and financially. The children wanted Mom to own everything so they asked me if they could donate their naked ownership interest back to Mom.  I told them that we would have to complete the Succession first in accordance with Louisiana law, and that Dad's half would have to go to the children, but then once the children were put "in possession" of the property, they could donate it back to Mom. Everyone felt good that Mom would own 100% of the property and the other Succession assets.

There were no gift or estate tax issues involved in the transaction since the estate tax exemption in 2018 is so high ($11.2 million). In fact, the children may benefit in the long run because when Mom dies many years from now, the children will benefit from the step-up in basis of Mom's entire estate as it passes to the children.

This post is for informational purposes only and does not provide legal advice. Please do not act or refrain from acting based on anything you read on this site. Using this site or communicating with Rabalais Estate Planning, LLC, through this site does not form an attorney/client relationship.

Two Reasons Louisiana Residents Don't Like the Louisiana Usufruct

The Louisiana Usufruct is a form of ownership that no other state has. It is designed to make assets available to another (perhaps a surviving spouse) while preserving the rights of the naked owners (typically, the children.

But many families don't like the application of the Louisiana usufruct laws. Here are a couple of reasons why:

(1) The Surviving Spouse's Heirs May Get Nothing. Let's say Husband and Wife each have two children from prior marriages. They have $1,000,000. Husband dies leaving Wife the lifetime usufruct of his estate. So, the Wife continues to own $500,000, and Wife inherits the usufruct of Husband's $500,000. Wife has a Will leaving her entire estate to her two children.

After Husband dies, Wife spends $500,000 on her care and her basic living needs. Here comes the tricky part. When Wife dies with only $500,000 remaining in her name, the Husband's children come out of the woodwork and proclaim, "We get all of the assets in Wife's estate because her estate owes us $500,000.

So, Husband's children get everything and Wife's children get nothing. This is not what they intended by leaving each other usufruct. They did not intend for the heirs of the surviving spouse to be excluded.

(2) Another problem that comes up often in any usufruct situation (even in traditional families) is that when one spouse leaves the usufruct of the home to the surviving spouse, the surviving spouse cannot sell the home without the written permission of the heirs of the first spouse to die. This often causes friction between the heirs of the first spouse to die, and the surviving spouse.

Both of these circumstances can be solved but you need to plan ahead to solve these problems. Call 866-491-3884 from anywhere in the State of Louisiana to perhaps start a conversation about how your estate legal program can protect yourself, your spouse (if married) and your heirs the right way - and you get it right the first time!

Importance of Documenting the Accounts in a Louisiana Succession After the First Spouse Dies

We started working on a Succession today out of our Baton Rouge office. The wife had passed away. Her husband was talking to me about helping the family get the Succession complete. The couple had been married for about 20 years, but they each had children from their prior marriages. The deceased wife had two children. The surviving husband had three children. The husband said that, for now, the relationships were good between himself and the two sets of children. He was hoping that the fact that his wife's estate needed to be settled would not harm the relationships among all of the parties involved.

Usufruct To Spouse - Naked Ownership To Children

We discussed how her wife left a Will leaving him the lifetime usufruct of her estate, and she named her two children as the naked owners. He stated that he wanted his three children to inherit his estate when he dies.

He brought in a list of all of the various bank accounts and investment accounts. They had about five bank accounts, an investment account at Fidelity Investments, and they owned a home worth about $500,000. We discussed how important it is now to fully document all of the bank accounts, investment accounts, debts, credit card balances, funeral expenses, and medical bills outstanding, because when the husband later dies, the children of the two spouses will look back to how the assets were listed when the first spouse dies to determine who inherits what after the surviving spouse dies.

I gave the husband an example. I said, "Let's assume that the two of you owned bank accounts totaling $200,000 when your wife died. Let's also assume that the two of you had credit card and home equity debt of $40,000. Further, let's assume that there were $15,000 of funeral expenses. What all of this means is that when you die, your estate will owe your wife's children $65,000."

Usufructuary Accounting

He asked me how I came to that calculation. So I said, "Well the $200,000 of bank accounts are community property so you each own half of those accounts. As the usufructuary. you own your half of the accounts, and your estate will owe your wife's children her half of the accounts when you die. So, let's start with the fact that you will owe her children $100,000. Now, since there was $40,000 of community debt, your wife's share of that is $20,000, and you can deduct $20,000 from what you owe her children. And since there were $15,000 of funeral expenses, you can also deduct that amount from what you owe. So, $100,000 minus $20,000 minus $15,000 totals $65,000. That's the amount your estate will owe your wife's children when you die."

Then, we started talking about their home. The surviving husband said he intended to sell the home in a few months and move into something smaller. So I gave him another example regarding their home. I said, "Let's say you sell the home in six months for $520,000. At that moment, you converted a nonconsumable (the home) into a consumable (cash). If you sell the house for $520,000, you will get to keep all of the money, but upon your death, your estate will owe your wife's children $260,000 (one-half of the sales proceeds). 

The mistake many families make is that even though money typically does not go to the children upon the death of the first spouse, it is critical to properly document the assets as part of the Succession process. If things are accurately documented in the Succession (also known as "Probate") when the first spouse dies, it will make it much easier to accurately divide the assets after the surviving spouse dies. Shoddy records after the first spouse's death will likely lead to estate settlement disputes after the surviving spouse dies because the families will often have to "guess" at what assets and accounts existed years earlier when the first spouse died and there are no longer records from years earlier.

Louisiana Statewide Succession and Estate Planning Legal Services

If you want to set up an estate legal program and you live in Louisiana, whether you live in Baton Rouge, Covington, Metairie, Lafayette, Lake Charles, Shreveport, Monroe, or Alexandria, or if you've lost a family member and you want to make sure that the estate settlement is handled the right way to avoid disputes, now or later, among family members, give our Louisiana toll-free number a call at 866-491-3884, and we will be happy to have a conversation about how easy it is to do it the right way, the first time.