Bequeathing Taxable Assets Equitably Among Heirs Requires a Careful Plan

Q My mother recently passed away. Her estate of less than $500,000 was divided equally among my sisters and me. Included was an individual retirement account of $54,000. The bank disbursed the funds in $18,000 amounts to each of us. I understand that each of us is responsible for paying the income taxes due on this money at our individual tax rates.

Because I live in California and am in the 31% tax bracket, my share of the IRA holdings will be taxed to a far greater extent than either of my sisters’ IRA shares. Is there anything that could have been done to equalize the tax effect on these inheritances? Or is it just tough luck for me?

--W.R.H.

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A It is now. It’s too late to make the kind of moves that could have avoided the situation you find yourself in--a kind of “unfair” disbursement of assets because of the unequal income tax situations among heirs. The time to have acted was when your mother was planning the distribution of her estate.

Had she thought of it--and many people and their advisors never do--she could have arranged the distribution of her estate so that those assets subject to income taxes would have gone to the heir in the lowest tax bracket. Other assets not subject to income taxes could have been designated for heirs in higher tax brackets to equalize the true inheritance value of her estate among the heirs. A trust arrangement could also have been written to equalize the effective distribution.

Unlike most assets bequeathed at death, IRAs, Savings Bonds and other tax-deferred assets are subject to income taxes because this income was not taxed before the death of their holder. Such bequests are technically known as “income in respect to decedent,” or in the vernacular of accountants, “hot assets.”

With some planning, these assets can be bequeathed so as to minimize the tax bite.

Benefits for Later Social Security

Q My father postponed receiving Social Security benefits until turning age 70. As a result, his benefits were 115% of what he would have received had he begun drawing them at age 65. He is quite ill now, and my mother is wondering if her widow’s benefits will be 100% of what he was actually receiving or what he was entitled to receive at age 65.

--C.G.

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A Assuming that she is at least 65 and did not begin drawing spousal benefits until at least that age, she as a widow would be entitled to receive 100% of what the wage earner was receiving at the time of death.

This rule is decidedly different from the one covering simple spousal benefits while both spouses are alive. In cases in which a worker postpones receiving benefits until after age 65, benefits for spouses 65 or older are limited to a maximum of 50% of what the worker would have received at 65. Spouses are entitled to share the worker’s “delayed benefit” only upon his or her death.

Taxes on Dual-Purpose Duplex

Q My husband and I are living apart for the time being, without benefit of a divorce or legal separation. We purchased a duplex for me; I live in one unit and rent out the other. He continues to live in the family home. What do we consider the duplex for the purposes of filing our income taxes this year? Is it half income property, half my potential replacement residence should there be a divorce? I’m concerned now because our tax filing this year will cast an important die for this property.

--C.G.E.

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A Our experts suggest that you consider the property half a second home and half income property. This designation will allow you to deduct the mortgage interest and taxes on both units (one as your second home, the other as income property) and still allow you to depreciate your income unit according to the standard depreciation schedule for income property of 27 1/2 years.

If you consider your half of the duplex as your replacement residence in the event the family home is sold, you would have to ensure that your family home will be sold within 24 months of the purchase of the duplex. Remember, replacement residences must be purchased within 24 months of--either before or after--the sale of the original home. The clock on your 24-month period began ticking when you closed escrow on the duplex. Given the fact that you’re not yet divorced, you may find it difficult to meet that schedule.

Furthermore, remember that to completely defer taxation on your share of profit from the sale of the family home, your replacement residence must equal or exceed 50% of the selling price of the family home. Because your duplex is half income property and half your residence, you could only consider half its cost as your replacement residence.

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Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053 Or send electronic mail to carla.lazzareschi@latimes.com