How to Administer a California Living Trust
Many Californians have living trusts. The creator of the living trust is called the Trustee (usually parents, uncles, aunts, grandparents, etc). As long as the Trustees are alive, they are in-charge of their trusts. A living trust usually appoints a successor trustee who will execute the trust in accordance with the trust’s terms when the trustee dies. These successor trustees are normally the daughters, sons, brothers, sister, etc. A living trust avoids probate. However, there are many formal steps that must be done to ensure proper execution of the trust, to carry out the Trustee’s wishes, and be in compliance with the California Probate Code. This process is known as trust administration. If you were named as the successor trustee of a living trust and were expected to act as the successor trustee tomorrow, would you know what to do without getting yourself into trouble? This article will summarize the trust administration process, and help you avoid pitfalls along the way.
How to Begin a Trust Administration
California Probate Code Section 16061.7 requires that a formal notice be sent to the beneficiaries within 60 days of the date of death of the trustee. This notice is very important because by sending out the notice to the beneficiaries, the successor trustee can shorten any trust litigation from the beneficiaries from four years to a mere 120 days. This is a very powerful arsenal for successor trustees to insulate themselves of liabilities from the trust’s beneficiaries. In addition, if a Pourover Will exists, you MUST “lodge” it with the within 60 days of the date of death of the trustee. This notice is very important because by sending out the notice to the beneficiaries, the successor trustee can shorten any trust litigation from the beneficiaries from four years to a mere 120 days. This is a very powerful arsenal for successor trustees to insulate themselves of liabilities from the trust’s beneficiaries. In addition, if a Pourover Will exists, you MUST “lodge” it with the court..
Dealing with Real Property
One of the largest assets in a living trust is a house. The successor trustee must follow certain steps in order to vest title in the successor trustee so that the house can be sold and managed. An Affidavit of Death of Trustee along with a certified trustee’s death certificate must be recorded with the county assessor’s office. Because death constitutes a change of ownership, a Preliminary Change of Ownership must be filed with the county assessor’s office within 150 days of the trustee’s death. If the living trust is giving the house to the children or grandchildren then the appropriate exemption form must be filed to retain the old property tax basis in order to save the children/grandchildren thousands of property taxes annually. (Propositions 58 and 193 allow the children or grandchildren to retain the old property tax basis)
Collecting Other Assets & Appraisal
The successor trustee will want to get a tax identification number from the IRS for the trust. It is important that all cash and investment accounts be placed in an account under the trust’s tax identification number so that the successor trustee is not personally liable for the income tax. There might be situations where the successor trustee discovers that certain assets were not placed in the trust; the successor trustee would petition the court to confirm that such assets be placed into the trust so that the successor trustee can administer all the trust’s assets accordingly. After all assets have been identified then the successor trustee might want to get appraisals for the trust assets.
Paying Debts & Taxes
It is the successor trustee’s responsibilities to pay all valid debts and taxes. It is imperative that the successor trustee understands California Code of Civil Procedures 366.2. This California’s law sets a strict 1-year statute of limitation on all unsecured creditors’ claims against the dead. Therefore, if mom died more than 1 year ago with credit card debts of $100,000 and left a $500,000 home with no mortgage against it, 366.2 says the successor trustee does not have to pay for the $100,000 credit card debts even though there is a house free and clear left by mom if more than 1 year has lapsed since the date of death.
If the total estate value is more than $5.4 million then an estate tax will be imposed and the successor trustee would need to file Form 706, which is due within 9 months of the date of death. This is in addition to the income tax return form 1040 for the deceased year of death and form 1041 for income earned by the trust. Because a successor trustee may be held personally liable for the estate’s debts and taxes, it is advisable for him or her to seek professional help in this area of trust administration. Some say that being a successor trustee is a thankless job for this reason because quite often the distribution among the siblings are equal shares but yet the one sibling who is the successor trustee has a fiduciary duty to the other siblings and thus, bears the responsibilities of carrying out the terms of the trust in accordance with the California Probate Codes and the California Uniform Prudent Investor Act.
Accounting and Distribution
After all of the trust assets have been dealt with, taxes are paid, and all debts are paid, an accounting of all the trust’s money has been rendered then the successor trustee will be in a position to distribute the money to the beneficiaries. Successor trustee will need to be aware of sub-trusts because it is common that the trust dictates certain assets be held in a sub-trust for minors or for other persons. In that case, the successor trustee will need to fund or put assets into that sub-trust.
It is important that the successor trustee understands the trust administration process because the California Probate Codes requires that the successor trustee follow these rules. If you are not familiar with the trust administration process you can get advice from a probate attorney.
Appraisals in Trust Administration
In probate cases, probate referees are appointed by the courts to appraise the value of the decedents ’ assets. The probate referee’s valuation will be reviewed by the court. If someone dies and he or she has a trust then no probate is needed. However, many of the procedures that are taken in a probate are still applicable to a trust. If someone dies having drafted a living trust, there is no probate proceeding but rather the process is called a trust administration. A trust administration is NOT a court-supervised proceeding, like a probate, but rather the successor trustee will manage the trust’s assets in accordance with the terms of the trust in strict adherence to the California Probate Code.
The probate court uses the appraised value to calculate the attorney’s statutory fees, to calculate loss or gain on sale of real property, and the IRS uses that value to calculate capital gains and estate taxes due. In a trust administration, it is critical for the successor trustee (this is normally the son or daughter who becomes the trustee when mom or dad dies) to have all the real estate appraised. The appraised value is important because it establishes the new cost basis of the real estate. For example, mom might have bought the house for $100,000 forty years ago but what she paid for it is irrelevant because her property was placed in the trust. When the son or daughter inherits the house that was placed in a trust, he or she needs to know the value of the house as of the date of mom or dad’s death. Why? Because that value at the date of death represents the new cost basis for the son or daughter. Mom might have paid $100,000 for the house forty years ago but if now it is worth $1,000,000, then the son or daughter’s new cost basis is $1,000,000. If the son or daughter sold the house for $1,000,000, the true economic gain is $900,000 but for capital gains tax purposes the gain is ZERO and thus, the son and daughter pays zero capital gains tax.
Therefore, it is important to have this valuation done by a reputable appraiser in case the IRS needs to see the appraisal report. The valuation will play a huge role in tax savings because it essentially eliminates the "unrealized" capital gains that existed at the time of the decedent’s death. Furthermore, if it is a rental property, the appraised value would become the new basis for depreciation purposes per Internal Revenue Code §1014. Thus, even if the son or daughter does not intend to sell the property and continues to rent it out, they would need to know their new cost basis for depreciation purposes.
Another reason why an appraisal is needed after mom and dad have passed away is for estate tax purposes. As of 2016, the estate tax exemption is $5.45 million per person. That means an individual can leave $5.45 million to their heirs and not pay any estate tax. A married couple will be able to shield $10.9 million from federal estate tax. Therefore, the IRS will add up all your assets, using your valuation report and if the total valued assets are more than $5.45 million per person, anything over the $5.45 million will be taxed at a 40% rate.
From time to time, the real estate market may drop dramatically after the decedent’s passing. Thus, it might be advantageous to use another date other than the date of death in order to get the best tax advantage. IRS Code 2032 allows the estate to elect the alternate valuation date, which is 6 months after the date of death, if the estate is subject to the federal estate tax (in 2016, the estate is subject to estate tax if the value of the estate is greater than $5.45 million) and the use of the alternative date will reduce the federal estate tax due. Therefore, a nontaxable estate cannot use the alternate valuation date. It is important to keep in mind, when using the alternate valuation date, the lower alternate value might lock in the lower value of the real estate cost basis but could result in higher capital gains taxes when the real estate is later sold. The alternate valuation date was enacted by the IRS in 1935 in response to the Great Depression.
Furthermore, a valuation of all the assets will allow the successor trustee to determine whether the current insurance policy is adequate for the trust’s asset, after all, the successor trustee does have a fiduciary responsibility to safeguard all trust’s assets.