A change of residence that produces certain benefits could create unanticipated tax, legal and people issues.

When people move from state to state, financial, tax, legal, and people issues should be considered.  Otherwise, a move that produces certain benefits could create unanticipated costs.

People move from state to state for a variety of reasons.  In their youth, they may move to attend college.  During their prime working years, they may move to change jobs.  In retirement, they may move for non-financial, or people, reasons such as weather conditions.  After nine feet of snow this past winter in Boston, Florida looks even more attractive.

Financial planning involves a coordinated discussion of the financial, tax, and legal issues, such as:

  • Income taxes

  • Estate taxes

  • Cost of living

There are also people issues, such as:

  • Quality of medical and custodial care

  • Proximity to friends and family

  • Access to favorite activities

Here are some recent examples of clients or parents of clients whose move from state to state created opportunities as well as problem.

First Example: One client’s mother died at 65.  Her estate carved out the then $600,000 unified credit amount and funded a family trust for the benefit of her surviving husband, my client’s father.  The cost basis of those assets today is the same $600,000 due to a step-up in cost basis to the fair market value at her death.

After father retired, he moved from Massachusetts to Virginia to be closer to another child.  Now, father is 92. The value of mother’s trust has grown to $1.5 million, but it still has the same $600,000 cost basis. These assets are not included in father’s taxable estate, but as a result do not benefit from a second step-up in cost basis at his death. 

Massachusetts has an estate tax on estates over $1 million measured by the Federal credit for state death taxes.  Virginia does not have an estate tax.  Even if we combined father’s estate assets with mother’s trust, father’s estate would be under the current $5.43 million federal estate tax exemption.

Therefore, there will be no federal or state estate taxes upon his death.  But, his children, my client and his sister, will likely sell the assets in their mother’s family trust upon their father’s death.  The children will incur a capital gain on $900,000.  Assuming a combined federal and state capital gain rate of 20 percent, they will lose $180,000 to capital gains taxes.

So, we recommended that the deceased wife’s family trust distribute its principal to the surviving husband.  That’s right.  We are recommending that we increase father’s taxable estate.  Why?  So, we can get a second step-up in cost basis.

Even if they still live in a state that has an estate tax, you should calculate the estate tax vs. the capital gains tax.  For example, let’s assume that adding the family trust to father’s estate would increase his estate from $1.5 million to $3 million. 

In Massachusetts, the estate tax on $1.5 million is $64,400 compared with the estate tax on $3 million, which is $182,000.  Paying $117,600 more state estate taxes saves $180,000 of federal and state capital gains taxes. 

If father’s estate increased to $3.65 million then his Massachusetts estate tax would be $244,000, which increases his estate tax by $179,600 to save $180,000 in capital gains.  Beyond that, adding to his taxable estate would create state estate taxes in excess of the federal and state capital gains tax savings.

But, since he moved to Virginia, adding to his estate up to the federal $5.43 million would still generate the capital gains savings without incurring estate taxes.  In fact, with a 40 percent federal estate tax on assets in excess of $5.43 million, father’s estate could grow to $5.88 million, at which point there would be (in this example) federal estate taxes of $180,000 equal to the capital gains savings.

You have to do the math.

Second example. Another client’s parents retired and moved from Massachusetts to Florida, which has no estate tax. Father died. Mother now has advanced Alzheimer’s.

The children (my client and his sister) want to move her back to Massachusetts to live closer to them so that they can be involved and supervise her daily care.  Her estate is greater than the Massachusetts $1 million filing exemption.  Mother’s $3 million estate will result in state estate taxes of $182,000 instead of zero in Florida.

Do the people concerns (her personal well-being) outweigh the financial, tax, or legal issues (increased taxation, and therefore, reduced inheritance)?  With the available $5.43 million federal gift exemption, mother could reduce her taxable estate to below the $1 million filing exemption, depending on the cost basis of the assets gifted. 

A low basis, highly appreciated asset gifted out of her estate would result in capital gains upon sale by her heirs.  Under the Federal credit for state death taxes used by many states to compute their state estate tax, the estate tax rate does not reach 15 percent until $9 million of assets vs. a 15 percent federal capital gain rate (or higher depending on adjusted gross income) plus state capital gains taxes.

Third example. An existing client couple bought a house in Florida and planned to change their primary residence (domicile) to Florida. But they still want to own the house in Massachusetts they bought years ago (low cost basis).

There are lower income taxes and no estate taxes in Florida. However, they will lose the $500,000 step up, in addition to basis, upon the sale of their primary residence if they subsequently sell the Massachusetts house during their lifetime.  It must be your primary residence for at least two of the last five years before sale.

We recommended that they consider selling the current house to their children to take advantage of this $500,000 step-up, but this action depends on the amount of the capital gain they will incur.  So, for example, if they bought the house for $100,000 and it has a fair market value of $750,000 today, they would pay capital gains on $150,000 ($750,000 – $100,000 = $650,000, then $650,000 – $500,000 = $150,000). 

The gain could be lower if they have receipts for improvements made.  Assuming a combined 20 percent federal and state capital gain tax, they would pay $30,000 in taxes now.  If they sold the current house beyond the period where they could use the $500,000 step-up, they would pay $130,000 in capital gains (20 percent of $650,000).  Their savings would be $100,000. 

If they kept the house until they died, then asset would get a step-up in cost basis and no capital gains would be due. The optimal answer for them depends on whether they might sell the house at some point in the future when it is no longer their primary residence.