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When did you (or your parents, grandparents, or other loved ones) last update your estate plan? If it’s been a while, the trust could contain a costly mistake that could lead to unnecessary taxes.

Beach Cities Estate Law clients don’t have to worry about this issue for their trusts — we’ve already ensured their estate plans are structured correctly. But what about your parents, siblings, or friends? Many people assume everything is in order because they already have a trust, but that’s not always the case.

The Problem With Older Trusts

Older estate plans were designed to save on estate taxes by splitting a married couple’s assets into two separate trusts after the first spouse’s death. This structure was once essential, but today, most families don’t need this tax savings due to the much higher estate tax exemption.

Unfortunately, these outdated trusts can create a different tax problem — one that leads to significant capital gains taxes on appreciated assets after the surviving spouse’s death. Here’s an example:

• A married couple buys a home in the 1970s for $100,000, and when the first spouse dies in the early 2000s, it is worth $1 million.
• Assuming that the house is community property, the home’s tax basis is adjusted to $1 million at the first death, which allows the surviving spouse to sell it (if they desire) with minimal capital gains taxes.
• Let’s assume the surviving spouse keeps the house, and it appreciates $800,000 between the first death and the second death.
• If the trust provides for a split into two trusts after the first spouse’s death “to save estate taxes,” 50% of the house would be allocated to this “tax savings trust.”
• The end result: The 50% of the house owned by this “tax savings trust” would NOT receive a basis adjustment at the second spouse’s death.
• When the children sell the house after the second spouse dies, they will owe capital gains tax on $400,000 (the gain on the 50% of the house held in this “tax savings trust.”)

Here’s how to identify an estate plan with this hidden tax trap.

Although we recommend that you review your estate plan every five years or so (more often if there are changes in your family or financial situation), here are some red flags that indicate that the trust is really out of date:

• The trust was created before 2012.
• The trust splits into two sub-trusts after the first spouse passes away.
• The trust contains terms like A/B Trust, Credit Shelter Trust, Bypass Trust, or Exemption Trust.

What happens if you do nothing?

If the plan is not updated, the beneficiaries — which could be you — could be stuck with a tax burden that could have been avoided. In administering trusts created by other firms that were not properly updated, we’ve seen cases where families inherited real estate and ended up paying six figures in capital gains taxes that could have been completely avoided with proper planning.

How can this be fixed?

If both spouses are still alive, the trust can be amended and restated without involving any other persons. If one spouse has already passed, it will take additional steps, and the remainder beneficiaries will need to be involved, but we can still correct it before it’s too late.

We understand that estate planning isn’t always an easy conversation to have with your loved ones. But it’s a conversation that could save them (and you) a lot of stress and money down the road.

If you’re reading this and thinking, “I don’t know if my parents’ plan is outdated,” that’s exactly why we’re here. Estate planning isn’t just about having a trust — it’s about having a trust that actually works in today’s world.

Call us today to schedule a complimentary consultation with a member of our team, because peace of mind is priceless!