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

The Louisiana Usufruct: Who is Liable for Repairs?

This post describes who is liable for repairs when someone owns the usufruct of property, while others are naked owners.

It's common in Louisiana for a spouse to leave their surviving spouse the usufruct of property. Here's an example: Wife and Husband marry, each for the second time. They each have children from their prior marriages. Wife owns the home they live in. Wife doesn't want Husband to be homeless if she predeceases him, so she writes a will and leaves Husband the lifetime usufruct of her home, and she names her children (Husband's step-children) as the naked owners of her home.

Wife dies. Husband and Wife's children somehow cooperate enough to complete the Succession. Husband is now living in the home. And let's say the home is 40 years old and in need of constant repair. Who is responsible for these repairs. The usufructuary? The naked owners?

There are several Louisiana laws that address liability for repairs in these circumstances. The general rule is that the usufructuary is responsible for ordinary maintenance and repairs, while the naked owner is responsible for extraordinary repairs, unless the usufructuary's fault or neglect cause the extraordinary repairs to become necessary.

Extraordinary repairs are those for the reconstruction of the whole or a substantial part of the property subject to usufruct. All others are ordinary repairs. As you might imagine, usufructaries will argue that all repairs are extraordinary. Naked owners will argue that all repairs are ordinary. 

During the existence of the usufruct, a naked owner can compel the usufuctuary to make the repairs for which the usufructuary is responsible. 

But the usufructuary may not compel the naked owner to make the extraordinary repairs for which the naked owner is responsible. And if the naked owner refuses to make these extraordinary repairs, the usufructuary may do so, and the usufructuary shall be reimbursed without interest by the naked owner at the end of the usufruct.

If, in the above example, the usufruct does not end until the death of the usufructuary, then the usufructuary's estate will likely seek this reimbursement from the naked owners after the usufructuary dies.

In addition, there are even more rules that address when, for example, a usufructuary abandons his usufruct, or when property has been totally destroyed through accident, but this post should give the basic information you may be looking for regarding the liability for repairs.

Make sure you address these things the right way on the front end so they don't became a disaster on the back end. Work with the right estate planning attorney who will listen to your objectives and suggest the best ways for you to leave a legacy behind - instead of a mess that winds up in court.

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

If You Have Usufruct, You Have Debt

This post should help you understand the full consequences of either leaving someone the Louisiana usufruct of an estate, or inheriting the usufruct of an estate.

Here's an example. Dad dies leaving a Last Will which left the usufruct of his estate to Mom. Together, Mom and Dad had about $1 million in the bank (checking, savings, and a number of CDs). About a year later, after Dad's Succession was complete, all of these bank accounts were put in Mom's name only - which the usufructuary is permitted to do. Family circumstances warranted that Mom change her Will. Mom died a couple of years after that.

All of Mom's heirs assumed that since all of the money was in Mom's name, and that Mom left a Last Will and Testament, that all of the money would go to them. But there were dead wrong - pun intended.

Since Dad left Mom the usufruct of his estate, Mom (or Mom's estate) owed a debt to Dad's heirs (also called a usufructuary accounting due to the naked owners). Dad had left Mom the usufruct of about $500,000. That "usufructuary debt to Dad's naked owners" needed to be satisfied first before any of Mom's heirs inherit a penny.

And if Mom had spent some of the money and only had enough at her death to satisfy the usufructuary debt, then Mom's heirs would not inherit - even though she had a very clear Will leaving her money to her heirs.

While usufruct can be appropriate in some circumstances, you and your spouse need to be aware - on the front end - about what might happen on the back end. While usufruct might be the way to go, there are a number of other alternative ways you can leave your estate to your loved ones. To start a discussion, call our office at 866-491-3884.

Go TIgers!

Leave Assets To Spouse In Usufruct Or In Trust?

One all-important discussion that often gets overlooked in the estate planning process involves how married couples leave their assets to each other. In Louisiana, couples have options that are not available to couples who live in other states.

A couple of the options that married couples in Louisiana have when they are deciding how to leave assets to their surviving spouse are: (1) leave the usufruct of assets to their surviving spouse; or (2) leave assets in trust for the surviving spouse. Let's take a closer look at each of these options.

Leaving Usufruct To Spouse

Let's say Fred dies with an estate of $1 million of cash. He leaves his wife, Ginger, the lifetime usufruct of his estate. So, after Fred dies, Ginger has her own $1 million, and she also has the usufruct of Fred's $1,000,000. As the usufructuary of Fred's $1 million of cash accounts, she becomes the owner of them with an obligation to pay Fred's heirs this amount when she dies (from her estate). 

After Fred dies, Ginger lives another 25 years, spending some of the money. When Fred died, Ginger had $2 million ($1 million of her own, and $1,000,000 in usufruct). 25 years later when Ginger dies, Ginger's estate only has $900,000 remaining (she spent $1.1 million. Ginger has a Will leaving her estate to her children. Who gets Ginger's $900,000? Well, Fred's children get it and Ginger's kids get nothing. Ginger's estate owes Fred's kids $1 million. Since there is only $900,000 in Ginger's estate, all of Ginger's estate must be used to satisfy her "usufructuary debt." Ginger's kids are bitter.

Leaving Assets in Trust for Spouse

Now, let's say, Fred establishes his Will or Trust to leave his $1 million in trust for his wife so that she has the ability to use the money for her health, education, maintenance and support (the customary HEMS standard). After Fred dies, Ginger uses half of these funds for her HEMS, and only $500,000 remains in the "Fred Trust" when Ginger dies. Ginger was able to keep $500,000 of her own money because she used some of Fred's money for her needs. When Ginger later dies, Fred's heirs get the $500,000 in the Fred Trust, and Ginger's heirs get her $500,000. Everybody is satisfied and everyone feels this is more fair than the usufruct situation.

Bottom line: Make sure you understand the consequences of different types of bequests to your spouse. What you do today could cause some very hard feelings and unintended consequences in the future.

Louisiana Couple With Young Adult Children Can't Leave Everything To Each Other

I met with a middle-aged couple yesterday from Prairieville. They wanted to get their legal affiars in order. They said that getting their legal affairs in order had been on their "to-do list" for a few years, and they were glad they were now getting it taken care of.

They were wanting to keep things as simple for themselves as possible. They indicated that they each wanted Wills leaving everything to the surviving spouse, and then after both spouses died, they wanted everything to go equally to their three adult children, who were 18, 19. and 21.

I let them know that, at least for now, they could not leave everything to each other. Since they still had children who were forced heirs (age 23 or younger), they are forced by Louisiana law to leave their children an inheritance.

I told them they could satisfy these forced heirship rules by leaving their surviving spouse the usufruct of their estate, and naming the three children as the naked owners. Under this scenario, protections would be in place after the first spouse dies to ensure that when the surviving spouse dies, the children of the first spouse to die will receive the inheritance from the first spouse to die.

Example. Mom dies and leaves the usufruct of her estate to Dad, and Mom's Will lists the three children as the naked owners. Mom dies. Years later, Dad remarries New Wife and changes his Will so that his estate goes to New Wife. Since Mom left the usufruct of her estate to Dad and names Mom's children as the naked owners, then when Dad later dies, Mom's estate must go to the children before any of Dad's estate can go to New Wife.

I've written quite a bit more about this in my book, "Estate Planning in Louisiana, A Layman's Guide," but if you have children who are 23 or younger, realize you will not be permitted to leave your estate entirely, in outright ownership, to your spouse. You must satisfy the Louisiana forced heirship rules.

What Should Louisiana Residents Do With Their Series EE or Series I Savings Bonds When Planning Their Estate?

I was working with a couple yesterday in our Baton Rouge office. Their neighbor had used our services and were satisfied, so they wanted to get the same peace of mind knowing that all of their legal affairs were in order. They discussed with me what they owned: home, IRAs, bank accounts, vehicles...the usual stuff.

I asked them if they were worried about the prospect of losing everything if they had a nursing home situation. She shook her head up and down and stated that it was one of her biggest concerns. They had an estate the size of which they needed to protect because it was more than what they are allowed to have and qualify for Louisiana Long Term Care Medicaid, but it was not so much that if they spent just a few short years in a nursing home, it would all get eaten up by nursing home costs.

So we started a discussion about how simple it would be to protect the value of their home from Medicaid's Estate Recovery lien, which if the home was not protected, would allow Medicaid to force a sale of the home after they both died to reimburse Medicaid for what it had spent on their nursing home expenses. We also discussed how easy it would be to protect their bank savings, particularly because they were starting the planning process while they were still healthy.

The wife went on to tell me that she had purchased a long term care insurance policy years earlier, but the insurance company would not permit the husband to buy a policy because of some health concerns.

We kept talking about some of the issues involved in protecting their IRAs from nursing home expenses. We discussed the Community Spouse Resource Allowance which allows married couples to protect more than $100,000 of the IRA and other assets if only one spouse enters a nursing home while the other stays at home.

We all felt that we had come up with a good strategy to protect what they had worked for from nursing home expenses, and also from probate, and as I was summarizing all of the details of their program, she said, "Oh, I almost forgot...I have all of these Savings Bonds. What do I do with these?"

She pulled an envelope out from which came a two-inch thick stack of United States Savings Bonds. I shuffled through them and discovered that some were in the wife's name only, some were in the husband's name only. Some were titled, "Wife OR Husband." And some were titled, "Wife OR Child."

She said, "What can we do to protect these Savings Bonds?"

I told her, "It's simple." Once your trust is signed - next time you come back to the office - you will be able to re-title all of your Savings Bonds into your trust by going to a special website. Transferring your savings bonds to your trust will prevent you from being forced to sell them and spend them if you go into a nursing home, AND, your son that you designated to handle your family's affairs when you and your husband die (the son's title is called the "Successor Trustee") will not have to fight with lawyers and the court system to get those bonds sold or transferred to your children equally when you die.

We pointed out to her that she will need to complete a Request to Reissue United States Savings Bonds to a Personal Trust, and that form is available online at http://www.treasurydirect.gov/forms/sav1851.pdf.

We told her that any questions regarding proper completion of this form could be directed to the Treasury at 1-800-245-2804.

We discussed how when the government re-issues a Series EE or Series I savings bond, it no longer issues a paper bond, and that the reissued bond is in electronic form - this actually makes things simple - don't have to deal with all that paper anymore.

We discussed how since she was transferring the bonds to their "Grantor Trust," the tax on the deferred interest would not have to be paid. The interest from the bonds would continue to accumulate tax deferred until the bonds were disposed of or they finally matured.

While some Louisiana residents have complex assets that are difficult to deal with when it comes to probate, Medicaid, usufruct, donations, gifting, Successions, taxes,  or re-titling, the government has actually done a pretty good job making it easy to re-issue United States Savings Bonds to a trust, allowing your clients to avoid all of the itemization of the bonds when they go through probate, and, if desired, allowing your clients to avoid being forced to sell and consume bonds if there is a nursing home situation.

If you own United States savings bonds and you want to simplify what your family will have to go through one day to get those bonds and other estate assets settled, whether it's when you die, when you become incapable, or perhaps even when you enter a nursing home, then give us a call at Rabalais Estate Planning, LLC, and we'll discuss, perhaps, a program to simplify all of this and leave your family a legacy instead of a headache.