Valuation of Assets at Death

When someone dies, it is necessary to value all the decedent’s assets.  This valuation is used to determine if a federal estate tax return is due, and the amount of estate tax, if any, which is payable.  The valuation is also used to determine the new income tax basis for assets owned by the decedent.  This valuation should be used whenever some dies and leaves assets, whether there is a federal estate tax return filed or not, and whether the decedent had assets in joint tenancy, subject to a living trust or covered by his or her will.

The valuation of assets at the death of an individual is determined by provisions of the Internal Revenue Code and regulations.  In some areas, it is very precise, while in other areas it is less precise.  The valuation procedure is the same whether the decedent died with sufficient assets to require the filing of a federal estate tax return, or the decedent had insufficient assets to require the filing of an estate tax return.

General rule for valuation
If the decedent was a United States citizen or permanent resident of the United States, he or she is taxed on all the assets owned anywhere in the world.  The value of the assets is the “fair market value” as of the date of death.  This is the price at which an asset would change hands between a willing buyer and willing seller, neither being under compulsion to buy or sell.

Valuation date
The valuation date is the date of death.  The federal government allows an alternate valuation date to be used for estate tax purposes, which is six months from the date of death.  All assets can be valued at either of those dates, but it is not possible to value some assets at the date of death and some assets later.  If the alternate valuation date is used, the value on both the date of death and the alternate date must be obtained and reported.

If the alternate valuation date is used, any assets that have been distributed or sold prior to the six-month period are valued, not at the end of the six-month period, but at the date of distribution or sale.  Any assets which change only due to a time factor, have the same value on both dates.  A bank account would be valued at the same value on both dates, since there is no change in value of the account, only additional interest from the date of death to the alternate date.

The alternate valuation date can only be used if it lowers the value of the estate for estate tax purposes, and lowers the amount of estate tax due.  If there is no estate tax due as of the date of death because the decedent’s total assets were worth less than the estate tax exemption, or if there is a surviving spouse and the estate is exempt from estate tax, then only the date of death value for all assets can be used.

Assets includable
All assets owned at death are subject to taxation.  This includes life insurance, securities, real estate, pension and profit sharing funds, IRA accounts, automobiles, furniture, income tax refunds for the year of death, and all other assets.  Even assets which are exempt from federal income tax, such as state bonds, are taxable for estate tax purposes.

If the decedent was married at the time of death, only the decedent’s half of any community property is includable along with all the decedent’s separate property.  Even though assets may avoid probate, such as assets in joint tenancy registration or subject to a beneficiary designation, they are taxable for estate tax purposes.

If the decedent owned a partial interest in an asset, such as a 25% interest in real property, then only the decedent’s partial interest is valued.

VALUATION OF SPECIFIC TYPES OF ASSETS

Real property
Real property is valued by obtaining a written appraisal for the property.  If the property is a single-family dwelling, a written appraisal can be obtained from a local real estate broker or agent.  This appraisal should be on the agent or broker’s letterhead, describing the property, the value, and how this value was determined.

For unimproved land or lots with a value of approximately $250,000 or less a written appraisal by a real estate broker or agent, as listed above, can be used.

For commercial property, such as an apartment complex, office building, farm, or similar types of property, an appraisal from a reputable appraiser needs to be obtained, and is more detailed than a simple “letter” report from an agent or broker.  It may run from a few pages to 10-20 pages.

Any costs of sale such as future brokerage commissions and other costs are not considered in valuing real property.

If a farm or ranch is involved, it is also necessary to value separately the farm equipment, livestock, and growing or harvested crops.

Stocks, bonds, and other securities
Stocks and bonds which are traded on a major stock or bond exchange or over the counter are valued by obtaining the average value between the high and the low for the security as of the date of death.  If a stock was selling between $18.50 and $19.50 per share on the date of death, the average, or $19.00 per share would be the value used. The closing price is not used.

If the decedent died on a weekend or holiday when the market was closed, the high and low price for the last trading date prior to the date of death and the next trading date after the date of death are then “re-averaged.”

For mutual funds, the value is the “bid” or public redemption price of that fund on the date of death.  If the decedent died on a weekend or holiday the bid or public redemption value of that fund is obtained for the last business day prior to the date of death.

With stocks which are trading “ex-dividend”  the amount of this dividend must also be reported, even though this amount is paid in the future.  For any bonds, accrued interest on the bond from the date of the last interest payment to the date of death must be reported.

In valuing bonds if there is no high and low for the date of death, the bond is valued by averaging the closing price on the date of death and the closing price on the last trading date prior to the date of death.

United States Treasury notes and bonds are valued the same as other bonds.

United States Treasury bills are valued at their redemption value, without interest, since interest is included in the price.

United States Savings Bonds, Series E, EE, and HH are valued at their redemption value for the month of death.  The federal government publishes tables each month showing the redemption value of these bonds depending upon their face amount and month and year of issue.  The value as shown on these tables is the same for the entire month.  Series G, K, and H savings bonds are valued at their face value at date of death, with no value for interest.

Cash
All cash must be listed.  If foreign currency is involved, it is valued at the current commercial or retail exchange rate on the date of death, or if the death is a holiday or weekend, it is obtained by averaging the exchange rate for the last business day prior to death and the first business day after death.

Any coins or bills which have a value at greater than their face value, such as silver certificates, are valued at their numismatic value.

Bank and savings and loan accounts
Accounts at banks, credit unions, and savings and loan associations are valued by taking the exact value in the account as of the date of death.  Any checks written prior to the date of death but which have not been deducted from the account as of the date of death should be reported separately, so that only the “net” value is listed.

Interest from the date of last payment until the date of death also must be computed and reported separately.

Mortgages and notes
If there were any loans outstanding at the date of death, either secured or unsecured, these are normally listed with the value as of the date of death and accrued interest from the date of last payment until the date of death.

A note may be reported at less than the balance or as uncollectable if satisfactory evidence is submitted to justify the lower value.

Partnerships, corporations, LLCs and business interests
Partnerships (limited and general), shares in a closely held corporation, interest in a limited liability company (LLC) and other business interests must be valued by determining the fair market value of the entity, and then valuing the decedent’s share or interest.  Frequently this is discounted.  Normally the accountant who handles the business tax returns would be the best person to determine the value.

Some partnership units for very large partnerships are traded on a secondary market and can be valued using the value that the units sell for on the date of death.

Vehicles, boats and airplanes
All vehicles, whether an automobile, RV, motorcycle, mobile home, and all boats and airplanes are valued separately by determining the sales value of the item at the time of death.  This can be done by checking various internet publications for automobiles and other items.  What a dealer would pay is not considered a proper valuation, but instead you would use what a buyer would pay to purchase the item.

Household furniture and furnishings.
Although the instructions from the Internal Revenue Service require an itemized appraisal of furniture and furnishings, most accountants disregard this and report the furniture and furnishings in a single entry, with a value of approximately $2,000-5,000.

The major exceptions are if the decedent’s will or living trust listed specific items, such as a diamond ring or piano, or if the decedent did have objects of significant value, such as a painting worth $10,000.  The federal estate tax return asks if there are any items of artistic or intrinsic value with any item valued at more than $3,000, or any collection of similar items valued at more than $10,000.

Life insurance
The proceeds received from any life insurance policy insuring the decedent’s life must be listed, even if the life insurance was owned by someone other than the decedent and is not taxable.  If a federal estate tax return is filed, it is also necessary to obtain a special IRS form (form 712) from the insurance policy for each policy.

If the decedent owned a life insurance policy on some else’s life, this policy must be listed and the cash value of the property as of the date of death must be reported.

Pension, profit-sharing, IRA, 401k, and other retirement accounts
All plan benefits under a retirement plan which the decedent had at death and which are paid after death to anyone are valued, using the rules set forth in IRS regulations.  If an IRA account was invested in stocks and bonds, these securities would be individually valued, using the rules for stocks and bonds.

Other assets
Any other assets are valued at death by attempting to determine their “fair market value.”  This would include book royalties, mineral interests, income tax refunds for the year of death, leaseholds, judgments, prepaid rents, taxes, annuities which continue with payments after death; and any other asset.

FILING OF FEDERAL ESTATE TAX RETURN

If the values for all the decedent’s assets as listed above for the decedent’s half of the community property and all the decedent’s separate property exceeds a certain amount, depending upon the year of death, a federal estate tax must be filed within nine months of the date of death (or an additional six-month period if there is an extension is obtained to file the return).  This is true even though there may be no tax due because of amounts passing to the surviving spouse, amounts passing to charities, or because of debts and expenses.  The amount of exemption before an estate tax return must be filed, depending upon the year of death, is:
2015    $5,430,000
2016    $5,450,000
2017    $5,490,000

If a federal estate tax return is filed, the Internal Revenue Service has up to three years to audit the return.  The service frequently checks values for traded securities and if these are incorrect they advise the person who filed the return and, if additional taxes are due, they bill for the taxes plus interest and possible penalties.

INCOME TAX BASIS OF ASSETS

If an estate tax return is filed, the new income tax basis of the assets for whoever inherits is the value shown on the estate tax return.  If no estate tax return is required, the value is the date of death value for each asset owned by the decedent, using the rules set forth above.

When a married person dies, and has assets in the decedent’s and spouse’s name as community property, or if the assets are held in a living trust as community property, then both the decedent’s half of each asset and the surviving spouse’s half both gets a new income tax basis at the date of death.  John Doe bought 100 shares of XYZ stock for $2,000.  He dies years later with the stock valued at $10,000.  The stock was held in a living trust as community property.  Both his 50 shares and his wife’s 50 shares would each get a new valuation, and the stock would now have an income tax basis of $10,000, with the $8,000 potential capital gain being canceled.  If the stock was all the decedent’s separate property, the same would be true.

If the decedent held the stock in joint tenancy with his wife, only the decedent’s half of the joint tenancy gets a new value.  In the above example, if the stock were in joint tenancy, then the decedent’s one-half, of 50 shares would get a new value of $5,000, while the wife’s one-half would stay at the original cost of $1,000.

If the decedent is not married at the time of death than all the assets listed on the estate tax return or owned at the date of death if there is no estate tax return get a new value at the date of death, even if the asset is in joint tenancy.

CONCLUSION

The valuation of assets at the date of death can be complicated and confusing.  It is important that the surviving spouse, children, executor, or trustee, whoever is handling matters, gets competent advice from an accountant or attorney to be sure that the values used are correct and those values will be used for trusts, estates and income tax purposes.

 

 

Converting a California Trust to a Unitrust

California passed legislation, effective January 1, 2006, which allows a trustee of an irrevocable trust (either a living trust or testamentary trust), to convert the trust from a “net payment of income” to a unitrust, without a court order, under certain conditions.  This can stabilize and increase the income paid to the trust beneficiary and make the administration of the trust easier for the trustee.

Trustees of California trusts should carefully examine their trusts to see if they meet these new requirements and if conversion should be considered.

Payments of income from a trust, whether coupled with discretionary payments of principal or not, frequently lead to problems.  For example, the trust beneficiary receives the “net income” from the trust and desires the highest amount of income possible.  The “income” consists of dividends on stock, interest and net rental income.  Capital gains from the sale of trust assets are “principal” and not part of the income paid to the trust beneficiary.

The trust remainder persons, who receive the principal on the beneficiary’s death, may desire the greatest appreciation of assets, with little or no concern regarding income.  With the dividends paid by stock companies, as a percentage of the price of a stock,  falling over the years,  and with interest rates declining in the last five years, the “net income” available to a trust beneficiary has fallen.

To compensate for this, the California legislature, in 1999, amended the Probate Code dealing with what is “income” and “principal” under provisions of the California Uniform Principal and Income Act (Probate Code sections 16320-16375).  This Act, which dates from 1962, defines in great detail what is income and principal and what expenses are charged to each.  Trustees are obligated to keep detailed records reflecting income and principal accounts for each trust.

The 1999 changes to this Act allowed a trustee, under certain conditions, to make adjustments in the income paid to a trust beneficiary by allocating some capital gains (normally principal) to income or increasing the income in other ways.  While the changes were useful, this adjustment provision could not be used if a trust beneficiary, such as the spouse, was the trustee.  Unless there was a co-trustee who was not a beneficiary of the trust or a bank acting as the sole trustee, this provision could not be used.

In 2003 the Internal Revenue Service issued trust income tax regulations (IRS Reg.1.643(b)-1) which provided that if a state statute provided that net income is a unitrust amount of no less than 3% or more than 5% of the fair market value of the trust assets, determined annually, or averaged over a multiple year basis, this would be taxed as “net income.”  These regulations allowed capital gains to be taxed to a trust beneficiary instead of to the trust, when the gain was distributed to the beneficiary.

Although California had an adjustment provision in the Probate Code, as mentioned above, it did not have any provisions for a “unitrust.”  The California Uniform Principal and Income Act was therefore amended, by amending Probate Code sections 16328-16338 and adding Probate Code sections 16336.4-16336.7,  to allow a method of conversion of a trust to a unitrust.

A unitrust is a trust where the assets are valued, usually annually, and the trust beneficiary then receives a predetermined percentage of this value for the following year.

If a trust had $1,000,000 in value on December 31st, the annual valuation date, and the trust paid a unitrust amount of 4% per year, the beneficiary would receive $40,000 the following year, or $3,333 per month.  The next December 31st the trust would again be valued and, based on the value, the trust beneficiary would receive 4% of that value for the next year, usually paid on a monthly basis.

Factors to Consider When Converting

Under a number of conditions, California law now allows a trustee to convert a trust to a unitrust, whether it is a testamentary trust under a will or a living trust.  California Probate Code sections 16336.4-16336.7 were added, effective January 1, 2006, and define the conversion process and steps which must be undertaken to legally convert a trust.

California Probate Code section 16336(g) sets forth a non-exclusive list of factors that the trustee may consider when deciding whether to convert an existing trust to a unitrust. These factors are as follows:

  1. The nature, purpose, and expected duration of the trust.
  2. The intent of the trustor.
  3. The identity and circumstances of the beneficiaries.
  4. The needs for liquidity, regularity of income, and preser­vation and appreciation of capital.
  5. The assets held in the trust; the extent to which they consist of financial assets, interests in closely held enterprises, tangible and intangible personal property, or real property; the extent to which an asset is used by a beneficiary; and whether an asset was purchased by the trustee or received from the trustor.
  6. The net amount allocated to income under other statutes and the increase or decrease in the value of the principal assets (which the trustee may estimate for assets which do not have readily available market values).
  7. Whether and to what extent the trust gives the trustee the power to invade principal or accumulate income or prohibits the trustee from invading principal or accumulating income, and the extent to which the trustee has exercised a power from time to time to invade principal or accumulate income.
  8. The actual and anticipated effect of economic conditions on principal and income and effects of inflation and deflation.
  9. The anticipated tax consequences of an adjustment.

Converting a trust

Unless prohibited by the governing instrument, a trustee or trustees of a trust may convert a trust, under Probate Code section 16336.4(b), to a unitrust if all of the following provisions apply:

  1. The three conditions set for in Probate Code section 16336(a) apply;
  2. None of the express prohibitions in Probate Code section 16336.4(h) applies;
  3. The unitrust is administered, under conditions as set forth in Probate Code section 16336.4(e); and
  4. The prescribed notice to trust beneficiaries is given and no beneficiary makes timely written objections.

Three preconditions

All of the three conditions in set forth in Probate Code section 16336(a) must be met.  They include the following:

  1. The trustee invests and manages the trust assets under the Prudent Investor Rule (California Uniform Prudent Investor Act -Probate Code sections 16045-16054). Most trusts operate under this rule;
  2. The trust describes the amount that shall or may be distributed to a beneficiary by referring to the trust’s income; and
  3. The trustee determines, after applying the rules for allocation of receipts and disbursements that are mandated by Probate Code section 16335(a), and considering any power the trustee may have under the trust to invade principal or accumulate income, that the trustee is unable to treat all classes of beneficiaries impartially, under Probate Code section 16335(b).

Conditions 1 and 3, above, are generally easy to satisfy.  Condition 2, above, is only a problem if the beneficiary or beneficiaries do not receive the net income but receive a fixed amount or some other described amount.  Personal residence trusts, charitable remainder trusts, and some other trusts will not qualify for the conversion.

Prohibitions regarding the conversion of a trust

A trustee may not convert a trust to a unitrust under Probate Code section 16336.4(h) in any of the following circumstances:

  1. If payment of the unitrust amount would change the amount payable to a beneficiary as a fixed annuity or a fixed fraction of the value of the trust assets.
  2. If the unitrust distribution would be made from any amount that is permanently set aside for charitable purposes under the governing instrument and for which a federal estate or gift tax deduction has been taken, unless both income and principal are set aside.
  3. If possessing or exercising the power to convert would cause an individual to be treated as the owner of all or part of the trust for federal income tax purposes, and the individual would not be treated as the owner if the trustee did not possess the power to convert.
  4. If possessing or exercising the power to convert would cause all or part of the trust assets to be subject to federal estate or gift tax with respect to an individual, and the assets would not be subject to federal estate or gift tax with respect to the individual if the trustee did not possess the power to convert.
  5. If the conversion would result in the disallowance of a federal estate tax or gift tax marital deduction that would be allowed if the trustee did not have the power to convert.

The above prohibitions will generally not apply to most regular net income trusts.  Unlike the inability of a trustee/beneficiary to use the adjustment powers mentioned earlier, a trustee who is also a beneficiary of the trust can legally convert a trust to a unitrust.

Notice requirements

Once the trustee decides to convert, without obtaining a court order, the trustee must give a notice of proposed action under Probate Code sections 16500-16504 to all trust beneficiaries, including minors and incapacitated adults.  Then, at least 45 days must elapse before making the conversion provided no beneficiary files a written objection to the proposed conversion.

In mailing notice, under Probate Code section 16336.4(c), the trustee must include with the notice all of the following:

        1. A statement that the trust shall be administered in accordance with the provisions of section 16336.4(e) (the unitrust amount and accounting year of the trust) and the effective date of the conversion.
        2. A description of the method to be used for determining the fair market value of trust assets.
        3. The amount actually distributed to the income beneficiary during the previous accounting year of the trust.
        4. The amount that would have been distributed to the income beneficiary during the previous accounting year of the trust had the trustee’s proposed changes been in effect during that entire year.
        5. The discretionary decisions the trustee proposes to make as of the conversion date, pursuant to section 16336.4(f), which covers the following:

(a) The effective date of a conversion to a unitrust.
(b) The frequency of payments in satisfaction of the unitrust amount.
(c) Whether to value the trust’s assets annually or more frequently.
(d) What valuation dates to use.
(e) How to value nonliquid assets.
(f) The characterization of the unitrust payout for income tax reporting purposes. The trustee’s characterization shall be consistent.
(g) Any other matters that the trustee deems appropriate for the proper functioning of the unitrust.

        • A copy of Probate Code sections 16336.4-16336.
        • Notice must be provided to all income beneficiaries and to “a beneficiary who would receive a distribution of principal of a trust if the trust were terminated at the time notice is given.”

Required terms of the unitrust

After a trust is converted to a unitrust all of the following rules must apply unless a court orders otherwise or all of the trust beneficiaries agree in writing to other terms, as provided in Probate Code section 16336.4(e):

1. The trustee shall make regular distributions in accordance with the governing instrument construed in accordance with the provisions of this section.
2. The term “income” in the governing instrument shall mean an annual distribution, the unitrust amount, equal to 4 percent, which is the payout percentage, of the net fair market value of the trust’s assets, whether those assets would be considered income or principal under other provisions of this chapter, averaged over the lesser of:

A. The three preceding years, or
B. The period during which the trust has been in existence.

3. During each accounting year of the trust following its conversion into a unitrust, the trustee shall, as early in the year as is practicable, furnish each income beneficiary with a statement describing the computation of the unitrust amount for that accounting year.
4. The trustee shall determine the net fair market value of each asset held in the trust no less often than annually. However, the following property shall not be included in determining the unitrust amount:

A. Any residential property or any tangible personal property that, as of the first business day of the current accounting year, one or more current beneficiaries of the trust have or have had the right to occupy, or have or have had the right to possess or control, other than in his or her capacity as trustee of the trust, which property shall be administered according to other provisions of this chapter as though no conversion to a unitrust had occurred.
B. Any asset specifically devised to a beneficiary to the extent necessary, in the trustee’s reasonable judgment, to avoid a material risk of exhausting other trust assets prior to termination of the trust. All net income generated by a specifically devised asset excluded from the unitrust computation pursuant to this subdivision shall be accumulated or distributed by the trustee according to the rules otherwise applicable to that net income pursuant to other provisions of this chapter.
C. Any asset while held in a testator’s estate or a terminating trust.

5. The unitrust amount, as otherwise computed pursuant to this subdivision, shall be reduced proportionately for any material distribution made to accomplish a partial termination of the trust required by the governing instrument or made as a result of the exercise of a power of appointment or withdrawal, other than distributions of the unitrust amount, and shall be increased proportionately for the receipt of any material addition to the trust, other than a receipt that represents a return on investment, during the period considered in paragraph (2) in computing the unitrust amount. For the purpose of this paragraph, a distribution or an addition shall be “material” if the net value of the distribution or addition, when combined with all prior distributions made or additions received during the same accounting year, exceeds 10 percent of the value of the assets used to compute the unitrust amount as of the most recent prior valuation date. The trustee may, in the reasonable exercise of his or her discretion, adjust the unitrust amount pursuant to this subdivision even if the distributions or additions are not sufficient to meet the definition of materiality set forth in the preceding sentence.
6. In the case of a short year in which a beneficiary’s right to payments commences or ceases, the trustee shall prorate the unitrust amount on a daily basis.
7. Unless otherwise provided by the governing instrument or determined by the trustee, the unitrust amount shall be considered paid in the following order from the following sources:

A. From the net taxable income, determined as if the trust were other than a unitrust.
B. From net realized short-term capital gains.
C. From net realized long-term capital gains.
D. From tax-exempt and other income.
E. From principal of the trust.

8. Expenses that would be deducted from income if the trust were not a unitrust may not be deducted from the unitrust amount.

The trustee can deviate from the above required terms under Probate Code section 16336.5(a).  The default rule for payment is 4%, but can be any percentage from 3-5%.  The trustee can also list assets to be excluded from the unitrust computation (other than listed in section 16336.4(e)(4)), and decide that certain assets be valued less frequently than annually, and that certain expenses be paid out of the unitrust amount.  If any deviation occurs the trustee must obtain the written consent of all trust beneficiaries or a court order. 

Administrative matters determined by the trustee

The trustee is required, under Probate Code section 16336.4(f), to determine all of the following matters as they relate to the administration of a unitrust.

1. The effective date of a conversion to a unitrust.
2. The frequency of payments in satisfaction of the unitrust amount.
3. Whether to value the trust’s assets annually or more frequently.
4. What valuation dates to use.
5. How to value nonliquid assets.
6. The characterization of the unitrust payout for income tax reporting purposes. However, the trustee’s characterization shall be consistent.
7. Any other matters that the trustee deems appropriate for the proper functioning of the unitrust.

Court order for conversion

In lieu of notice, or upon the timely written objections of a beneficiary when he or she receives notice, a trustee may petition the court to convert a trust to a unitrust.  Any trust beneficiary may also petition the court for such conversion.  The court shall approve the conversion to a unitrust if all the provisions of section 16336(a) are satisfied and the court determines that the conversion will enable the trustee to comply with section 16335(b), which provides the trustee shall administer the trust impartially. The court may not change the percentage payout below 3% or for more than 5%.

Reconversion or change in percentage payout

Once converted to a unitrust, a trust can be converted back to a “net income” trust or the percentage payout can be changed pursuant to Probate Code section 16336.6(a) provided the following conditions apply:

1. At least three years have elapsed from the conversion of the trust;
2. The trustee determines that the reconversion of change in percentage would enable the trustee to better comply with section 16335(b) (administering the trust impartially for all classes of beneficiaries); and
3. Written notice to all trust beneficiaries has been made with no timely objections.

While a trustee may not reconvert a trust or change the percentage payout for three years, a trustee can petition the court at any time, even within the three year period, to make these changes.

Discretionary principal payments from trust

If the trust document provides for discretionary payments from a trust (health, support, maintenance and education), the trustee is still free to make such payments even though the trust has been converted to a unitrust.

 Exculpatory provisions regarding trustee converting or not converting a trust

The trustee has no legal obligation to adjust or convert a trust and is not liable for not considering any adjustment or conversion. In any legal proceedings regarding an adjustment or conversion to a unitrust, the sole remedy is to obtain a court order directing the trustee to covert the trust to a unitrust, to reconvert from a unitrust, to change the distribution percentage, or to order an administrative procedure which the court considers appropriate.  The court can make adjustments but can not award a party damages because adjustments were not made.

Conclusion

Every trustee of a California trust that may legally be converted to a unitrust should review the trust document and determine if the trust can legally be converted to a unitrust.  If so, the trustee should determine the current annual income payments to the beneficiary or beneficiaries as well as what amount 4% of the trust value would produce.

The trustee should then carefully review whether the trust should be converted to a unitrust or not.

If a trustee decides to make a conversion, it is important to very carefully follow the Probate Code provisions on the conversion to avoid problems at a later date.

 

 

© Milton Berry Scott, 2006-2016.

 

 

 

 

Administration of a California Living Trust for a Single Person upon the Death of that Individual

A single individual establishes a revocable living trust and transfers assets into his or her name as trustee of the trust.  Then the individual dies.  What action has to be taken by the successor trustee or trustees of this trust?

California law requires that the trustee or trustees take certain legal actions.

A number of things have to be done, depending upon the terms of the living trust.  The successor trustee or trustees who are designated in the trust document must take some actions which are legally required by the trust document, California law, and federal tax law.

The first concern is determining who the successor trustee is?  In most trust agreements or trust declarations the original trustor or settlor was the sole trustee.  Upon that person’s death, a child or children are frequently the successor trustees.  The trustee or trustees have the legal responsibility to see that a number of actions are undertaken.  If these are not done or are done incorrectly, then the trustees may be liable for additional taxes or may be liable to the ultimate trust beneficiaries for mistakes which are made, even if made in good faith.

ADMINISTRATIVE TRUST
In most trusts, the assets are initially held in one trust, called an administrative trust, for a period of from 6-12 months, until all bills and debts are paid, values of all of the assets are obtained, an estate tax return is filed (if required), and all other legal matters are completed.

The successor trustee or trustees need to re-register the assets in the name of the successor trustee or trustees.  If Mary Doe established a living trust and upon her death John Doe, the son, is the successor trustee, then the assets should be re-registered in the name of “John Doe, Trustee of the Mary Doe Living Trust dated August 17, 1999.”  A certified copy of the death certificate and a copy or a certification of the trust need to be provided to each institution or party holding title to assets, such as stock brokers, mutual funds, banks, general partners of a limited partnership, and others.

 Tax Identification Number
In most cases the original trust creator, called the trustor or settlor, was the original trustee and no tax identification number was needed.  The party used his or her social security number for trust assets.  Upon the person’s death, a tax identification number must be obtained and used for all trust assets.

This tax identification number for the administrative trust needs to be obtained from the IRS.  This is done by completing IRS form SS-4 and submitting it to the IRS, completing an online form at the IRS website, or having a CPA or enrolled agent obtain a number for the trust.  The IRS will mail the number to the trustee or trustees within approximately four weeks.  This number is used in place of a social security number for all of the trust assets.  Trust income tax returns (federal and California) will also have to be filed as of December 31st of each year, starting in the year of death.

Trust Certification
California law allows a “certification” with regard to the trust.  This certification is merely a typed statement which lists the current trustee or trustees, tax identification number, powers of the trustee or trustees, and other pertinent provisions of the trust and is signed by the successor trustee or trustees and notarized.  This certification, or a copy of the trust document, along with a certified copy of the death certificate of the deceased, is submitted to each organization to transfer assets into the name of the successor trustee or trustees.

Change of Ownership Statement for Real Property
Whenever an owner of California real estate dies, it is necessary to file a special statement entitled “Change of Ownership Statement—Death of Real Property Owner” with the county assessor of each county where real estate is owned.  This notifies the county assessor whether the property is subject to reassessment for real estate tax purposes or is exempt.  A statement for each separate parcel of real estate is to be filed within 145 days of the date of death.  A copy of the trust agreement and all trust amendments should be mailed to the assessor with the form.

Death is a change of ownership and causes the real property to be reassessed for real estate tax purposes at its current value, subject to limited exemptions to spouse or children.

Change in Title to Real Property
An “Affidavit-Death of Trustee” is a real estate form which is recorded for each parcel of real estate in the trust, along with a certified copy of the death certificate.  This changes title of the property or properties into the names of the new trustee or trustees.

Preliminary Change of Ownership Report
Whenever any change of ownership for real property occurs, it is necessary to file a real estate form called “A preliminary change of ownership report.”  This document notifies the county assessor whether real estate is subject to reassessment or not.  This is normally filed whenever there is a document which is recorded which changes title of the real property, such as an “Affidavit-Death of Trustee.”

Real property passing to a spouse, children of the deceased, sons-in-law, daughters-in-law, and, in some cases, to children of a deceased child is exempt from reassessment.  The exemption applies to the residence of the decedent and to other real estate with a value of not more than $1,000,000 based on the assessed value as of the date of death.  Transfers to other relatives or someone who is not related to the deceased triggers a reassessment.  The property is reassessed as of the date of death at its fair market value and the real estate taxes are increased accordingly to 1% or more of this value.  A supplemental real estate tax bill is later mailed, if required, for the year of death.

Filing Original Will
California law requires that within 30 days of the date of death the original will of the deceased along with any codicils be filed with the county clerk in the county where the deceased resided at the time of death.  This includes all original wills and codicils, even if they have been revoked.  These documents are “filed” with the county clerk, and if there is no probate required, then there is no filing fee.  In addition, a copy of the will must be mailed to all persons named in the will as executor, even if probate will not later be undertaken.  The county charges a $50.00 fee for this.

Notifying all Trust Beneficiaries and Heirs
It is necessary within 60 days of the date of death to notify in writing all trust beneficiaries and the deceased’s heirs at law of the living trust and to send them a specially worded notice of the living trust and copies of portions of the trust.  Once the notice is mailed, then a party has only 120 days from the date of the mailing of the notice to contest the trust.  Each party must be advised of his or her right to contest the trust.  If the notice is not mailed, then a beneficiary may have up to four years or longer to contest the trust.  There are potential damages, including attorney’s fees and costs, if the trustee or trustees do not mail notice and comply with all of the legal requirements.

Notice to Creditors
There is a special provision in California law allowing a notice to creditors to be filed in a living trust similar to that used in a probate procedure.  This requires a filing with the county clerk and publication of a notice three times in a local newspaper.  The costs can run $700-1,000 in addition to attorney’s fees.  Special notice must also be mailed to any known creditors of the deceased.  Creditors then have maximum of four months to file a claim in the trust, with some exceptions.  If a claim is not filed and all procedures have been followed, the creditors lose their right to payment.

While this procedure is not legally required, if it is not done a creditor could have a period of up to three to four years to seek payment.  If the trustee does not use this procedure and a creditor later appears, the trustee or trustees may be personally liable because they failed to follow this procedure.

Valuation of Assets
It is necessary to value all assets in the trust as well as all assets which the decedent owned which were not in the trust as of the date of death.

The value which is used is the fair market value as of the date of death.  Stocks and bonds must be valued by taking the average between the high and the low as of the date of death.  If the deceased died on a weekend or holiday, the average between the high and low for Friday and Monday must be re-averaged.  Mutual funds take the closing price on the last business day prior to the date of death.  Other assets such as real property, partnerships, automobiles and certain other assets need a written or appraised value by a competent appraiser such as a real estate agent or broker for real property.  A valuation for all assets, in and out of the trust, should be obtained.  This includes life insurance, IRA accounts, 401k plans, etc.  Furniture and furnishings are not normally valued unless they have a high value.  Generally, a value of $2,000-5,000 is used for personal items.

This new valuation is also the “cost basis” for these assets when they are later sold.  All capital gains are forgiven at death and the assets are treated for income tax purposes as if they were purchased on that date at this new value.

Federal Estate Tax Return
A federal estate tax return must be filed if the deceased’s assets exceed a gross value of a certain amount.  This value is based on all assets, whether in the living trust or not.

If this total, before deducting any expenses or costs, exceeds the following amount, a federal estate tax return must be filed within nine months of the date of death.  If necessary, an extension can be obtained for up to six months to file the return.

Year of Death                             Exempt Amount
2015                                          5,430,000
2016                                          5,450,000

The tax rate on any amounts over the exemption is a 40% rate.

If a federal estate tax return is not required then the values used are the date of death values for all of the assets.

Probate

Normally, a living trust avoids probate.  However occasionally, someone dies and has too many assets outside the living trust.  These assets, not in the trust, may have to go through probate.

California does not require a probate unless the assets outside the living trust exceed the value of $150,000 as of the date of death.  In addition, this figure does not include any assets in joint tenancy, any vehicles including mobile homes, or any assets where a beneficiary is specifically named such as life insurance or IRA accounts.  If a probate is not required, then the trustee or trustees of the living trust have to wait for 40 days from the date of death.  They can then sign a special certification form and transfer the assets into the living trust, or to whoever is legally entitled to the assets.

If the total, outside the living trust and over and above the excluded assets listed above, is more than $150,000 as of the date of death, these assets will have to go through probate before they can be placed in the living trust.

 Trust Income Tax Returns
The income from January 1st until the date of death is taxed to the trustor.  The income from the date of death until December 31st will be taxed either to the parties who receive the trust assets or to the trust, depending on how matters are handled.  Trust income tax returns, federal and California, must be filed until the trust is terminated and assets are completely distributed.

DISTRIBUTION OF TRUST ASSETS
After the federal estate tax return is filed or, if there is no return, approximately nine months from the date of death, consideration is given to distributing the assets in the trust.  Assets in the trust can be sold or divided among various parties if the parties agree.  One beneficiary may wish to take California tax exempt bonds; another beneficiary may want the real property, etc.  Normally, division is made based on the values as of the date of distribution, again provided the parties agree.  If there is no agreement and the assets in the trust pass to three children, then each child would get one-third of each asset.

Once a decision has been made about the division of the trust assets, a detailed list should be prepared showing the allocation of assets to the various beneficiaries.  This list should itemize all of the assets with their value on the estate tax return or date of death value if no estate tax return is necessary and then show the allocation to the respective parties.  The list is then signed by the trustee or trustees and retained should any questions arise as to how the assets were divided.

If the trust continues in whole or part as a trust, then the trustee or trustees need to re-register assets in the trustees’ names, keep records, invest funds subject to the provisions in the trust document and California law, and provide the trust beneficiary or beneficiaries with an annual accounting.

Re-registration of Assets in Beneficiaries Names
After a division has been decided and a list signed, then the assets need to be registered in the names of the various beneficiaries. Again, each transfer agent, bank, brokerage firm, etc., is contacted and a transfer of title undertaken.  New deeds are recorded for each parcel of real estate.  After re-registration is completed, a receipt should be obtained from each beneficiary for the assets delivered and these receipts are retained by the trustees to show that the assets have been delivered.

Accounting
In addition, the trustee or trustees of any trust created after July 1, 1987, must file annual accountings with the trust beneficiaries, and also do an accounting upon a change of trustees and upon the termination of the trust.  Unless the accounting is waived by all of the trust beneficiaries, the accounting must show the assets on hand as of the date of death with their values, income received, disbursements, assets sold with the gain or loss being listed, and when distribution occurs.  The accounting must also show the assets on hand with both their date of death and current fair market values.

 SUMMARY
It is important to administer the living trust correctly upon the death of the trustor.  There are many legal requirements for the trustee or trustees when the creator of the trust dies and the trust assets are distributed.  Failure to follow the law properly can result in possible litigation, the trustee being personally liable for damages, and the trust being attacked by the Internal Revenue Service.

It is very important for the trustee or trustees to have an attorney and accountant or tax preparer that is familiar with the law and the handling and administration of trusts in California as advisors.

© Milton Berry Scott, 1998-2016
Revised January 5, 2016