When a Decedent's Estate is in the Chain of Title
June 20, 2005
Gelfond, New Jersey regional manager/counsel for United General Title Insurance Company of Fairfield, thanks Roxanna E. Hammett of Wolff & Samson of West Orange and Elissa Buonarota of Esquire Title Agency of Parsippany for their assistance in the preparation of this article.
State and federal tax issues top the list of significant issues to be dealt with in real estate closings involving decedents' estates
A number of title insurance issues may arise in connection with real estate closings when a decedent's estate is in the chain of title. This article covers some of the more common issues faced by real estate attorneys and title insurers.
Probably the most significant issues are tax issues. There are three categories of tax that may be relevant: Federal Estate Tax, Transfer Inheritance Tax and New Jersey Estate Tax.
Federal Estate Tax
Federal Estate Tax, 26 U.S.C. Section 2001, et seq., is assessed based upon the entire amount of the decedent's net estate and not upon the value of the real estate being transferred. The Federal Estate Tax rates range from approximately 18 percent to 47 percent of the taxable amount of the estate, i.e., the amount of the estate that exceeds the exemption, 26 U.S.C. Section 2001.
As of 2004, estates under $1.5 million are exempt from the Federal Estate Tax. In 2006, that exemption will rise to $2 million and in 2009, to $3.5 million. The tax is scheduled to be repealed entirely in 2010, only to be reinstated in 2011 with a $1 million exemption amount. It is likely that Congress will act before 2010 to eliminate this uncertainty. The Federal Estate Tax is a lien upon decedent's premises being transferred and the lien remains for 10 years.
In a real estate closing, if the premises involve a decedent's estate and it is determined that the Federal Estate Tax is applicable, there are three ways to address this lien in connection with the closing. The most desirable method of handling the lien, but usually the least practical, is to obtain proof that the return (IRS Form 706) has been filed and the tax due paid. The problem here is that the return and tax are due nine months after the date of death, and on larger estates it is difficult and often impractical for it to be submitted earlier.
In addition, after the return is submitted and the tax paid, the IRS upon audit may find the tax return to be incorrect or unacceptable. If so, it may ultimately be determined that the IRS is correct, and the tax submitted is insufficient to satisfy the lien. Compounding the problem, oftentimes it may be nine months or more until the IRS responds, indicating additional tax is due.
When the IRS ultimately reviews and finally accepts the computations set forth in the Federal Estate Tax return, and accepts the payment remitted, the IRS will issue what is called a Closing Letter. Accordingly, if the real estate closing is based upon actual payment of the tax, proof of filing of the tax return along with a copy of the cleared check is not sufficient to close. The IRS Closing Letter must also be presented.
A significant estate, to which the Federal Estate Tax applies, often takes one to two years to settle. Accordingly, waiting for the Closing Letter is usually not practical. A waiver may be obtained from the IRS to close before the tax return is finalized. This is called a Certificate Discharging Property Subject to Estate Tax Lien. It is obtained by listing all assets of the estate on IRS Form 4422 and submitting it to the IRS, requesting that the IRS issue a waiver. A response from the IRS usually takes two to three weeks. The IRS will scrutinize the submitted listing of the assets of the estate to insure that the IRS is secure, and will only issue the waiver if it is fully satisfied that there are sufficient available assets in the estate.
The most common procedure used to close on real estate before the IRS issues its Closing Letter is to hold funds in escrow; or sometimes, to give the title insurer an Indemnity Bond Against Debts. Title insurers have a form Questionnaire on Estate Debts to be filled out by the seller's representative - sometimes the attorney, sometimes the accountant and other times the executor or administrator.
This questionnaire is almost always accepted and relied upon to determine whether the federal estate tax and New Jersey taxes are applicable and, if so, how much must be held in escrow. Sometimes the entire sale proceeds are to be held and sometimes an amount needed to cover the estimated taxes is sufficient. However, there may be occasions where even the entire sale proceeds are insufficient.
Transfer Inheritance Tax
The New Jersey Transfer Inheritance tax, N.J.S.A. 54:33-1 et seq., is imposed on the value of the transfer of estate assets to heirs or devisees, not upon the value of the entire estate. This tax is described in Lawrence J. Fineberg, Handbook of New Jersey Title Practice, Chapter 54, Section 5401 (3d ed.), as follows:
The term 'transfer' may be somewhat misleading, because it primarily refers to changes in ownership arising by operation of law from the decedent's death. In addition to title passing by devise or descent, the tax is also applicable to certain joint tenancies. So if A and B own Blackacre as joint tenants, and A predeceases B, the interest acquired by B upon A's death is taxable, unless otherwise exempt.
The Transfer Inheritance Tax, where applicable, constitutes a lien upon the real estate conveyed. The lien remains in effect until paid for 15 years from the date of decedent's death. N.J.S.A. 54:35-5.
N.J.S.A. 54:34-2 sets forth the different classes of transferees and which categories of transfers are taxable and which are tax exempt for applicable time periods. It also sets forth the tax rates. Currently, Class A beneficiaries include spouse, ancestors and descendants. They are fully exempt from the tax.
Class C beneficiaries now include siblings, sons-in-law and daughters-in-law. After an exemption for the value of the first $25,000 of the transfers, the taxable rate for this class of beneficiaries is progressively scaled from 11 percent to 16 percent. Class D beneficiaries include all other individuals. There is no exemption applicable and the tax rate is progressively scaled from 15 percent to 16 percent of the transfer value. Class E beneficiaries are charities and they are fully exempt from the inheritance tax.
If the real estate being conveyed is owned by Class A beneficiaries the transaction is exempt from the inheritance tax. Once it is established that all heirs or devisees in title on the conveyed premises are Class A beneficiaries, most title insurers will waive the requirement in the title commitment that a New Jersey Tax Waiver be obtained. If a waiver is needed, a Form L-9, Affidavit of Resident Decedent Requesting Real Property Tax Waivers, can be filed if all of the beneficiaries are Class A and no New Jersey Estate Tax return is needed, i.e., the value of the estate is less than $675,000.
If the heirs or devisees conveying are Class C or D beneficiaries, a Tax Waiver must be obtained from the Inheritance and Estate Tax Branch, see N.J.S.A. 54:35-9. The Waiver should be recorded with the County Register/Clerk. After the final Inheritance Tax Return (Form IT-R) is filed and processed by the Branch, the Branch will issue a Notice of Assessment. Hopefully the Notice of Assessment will state at the bottom that there is a zero balance due and stapled to it will be the Tax Waiver.
However, the Inheritance Tax return and tax are not due to New Jersey until eight months after decedent's death. Oftentimes the property must be transferred before this tax issue is settled. To transfer free of the tax lien the waiver must be obtained and recorded. To obtain the waiver prior to the final return being filed, a preliminary return (Form L-4) is submitted. The Division of Taxation will review the preliminary return. If there are sufficient other assets in the estate, the Division may be willing to issue the waiver. However, if the Division of Taxation does not feel secure it may require that the
entire estimated tax be paid to issue the waiver.
A third alternative is to hold an escrow at closing. The amount of the escrow is based on determining the estimated total inheritance tax due. This is usually figured based on the estimated tax liability determined from the title insurer's Questionnaire on Estate Debts. The title insurer will insist that a sufficient cushion be held and this will sometimes result in the entire net sale proceeds being held in escrow until the waiver is obtained and recorded. The escrow agreement, however, often provides that the necessary portion of the escrowed funds may be released to pay the tax.
New Jersey Estate Tax
The New Jersey Estate Tax, N.J.S.A. 54:38-1, et seq., is sometimes referred to by title insurers and real estate attorneys as a "new" tax. In fact it is not a new tax but is a relatively new lien on real estate. N.J.S.A. 54:38-6 provides (under "Historical and Statutory Notes") that the lien applies to the estate of any resident decedent dying after Dec. 31, 2001. The duration of this lien is not set forth in the statute and thus is unknown. Lawrence J. Fineberg, Handbook of New Jersey Title Practice, Chapter 54, Section 5409 (3d ed.).
The New Jersey Estate Tax is based on the size of the estate and applies if the value of the total estate, for federal estate tax purposes, is over $675,000. The New
Jersey Estate Tax and Transfer Inheritance Tax offset each other. Accordingly, if the value of the estate is sufficient so that the Estate Tax is applicable, only the higher amount due of the two New Jersey taxes is payable.
The New Jersey Estate Tax used to be tied to the Federal Estate Tax. This is no longer true and it is now "decoupled" from the Federal Estate Tax. The New Jersey Estate Tax is equal to the state death tax credit that would have been applicable had the decedent died on Dec. 31, 200 I, when the Federal Estate Tax exemption was $675,000. The rate is approximately 10 percent. The tax is due nine months from decedent's date of death. The return to be filed is Form IT-Estate.
Similarly to instances where the lien of the Transfer Inheritance Tax applies, if real estate must be transferred prior to the New Jersey Estate Tax being paid, a waiver must be obtained. The same formalities are required to obtain a waiver as to the New Jersey Estate Tax as are required to obtain a waiver as to the Inheritance Tax, and the same issues apply. A Form L-4, a Preliminary Inheritance Tax Return is filed, showing all assets of the estate.
Also, if the property must be transferred prior to obtaining the waiver, where there are sufficient funds an escrow may be held at closing.
Lien of Estate Debt
A statutory Lien of Estate Debts is set forth at N.J.S.A. 3B:22-22. The statute provides that the decedent's debts are a lien against decedent's real property for a period of one year from date of death. However, because the heirs remain liable for the decedent's debts, the lien continues until the property is sold to a bona fide purchaser for value. Lawrence J. Fineberg, Handbook of New Jersey Title Practice, Chapter 54, Section 5410 (3d ed.).
If it is necessary to convey decedent's property before the statutory period has elapsed, an indemnity agreement from the executor or administrator is usually required. The amount of money to be held, if any, is usually based upon representations as to decedent's debts set forth in the estate questionnaire.
There is a misconception among some real estate attorneys and title insurers that judgments that have been entered against a decedent are somehow extinguished as a result of decedent's death. Sometimes this statute, N.J.S.A. 3B:22-22, is fallaciously relied upon in support of this position.
A judgment against the decedent, based upon the conduct, activity or course of dealing of the decedent, is not an "estate debt." If such a judgment is entered before decedent's death and is docketed against decedent's name as debtor, the judgment is a lien upon decedent's realty. A devisee, heir or grantee by deed of such realty takes title subject to that judgment lien.
Necessary Parties on Conveyances
If a decedent dies testate and, pursuant to the terms of the will, there is a specific devise of property, the specific devisee along with the executor or administrator must execute the deed conveying the premises. Under no circumstances can the requirement that the specific devisee execute the deed be omitted. In instances where there is no specific devise, the following considerations apply.
As discussed in Lawrence J. Fineberg, Handbook of New Jersey Title Practice, Chapter 53, Section 5323 (3d ed.) et seq. the Statute of Devise and Descent, N.J.S.A. 3B:I-3, the Fiduciary Powers Act, N.J.S.A. 3B:14-23 and the testamentary Power of Sale must be considered together. The Fiduciary Powers Act gives the executor or administrator a statutory Power of Sale, regardless of whether such Power of Sale is set forth in the Will.
Further, in Lawrence 1. Fineberg, Handbook of New Jersey Title Practice, Chapter 53, Section 5328 (3d ed.), it states:
It is important that testamentary powers of sale be exhausted, because- under pre-statutory law - the title derived through the executor was held to be superior to the title obtained from the devisees. It is unclear whether the Courts would reach a similar result in construing the statutory power of sale; for our purposes, we must assume they would. Therefore, one must not fail to obtain the executor's (or administrator's) signature (along with those of the devisees or heirs) on the deed or other document to be insured.
As previously noted, when an individual dies testate his or her property automatically, by operation of law, vests in the devisees. When an individual dies intestate, title to the property automatically vests in the heirs at law. Accordingly, good practice mandates that both the devisee(s) and executor, or heir(s) and administrator, execute the deed. Also, because upon decedent's death title automatically vests by operation of law, the grantor in the deed can never be the estate of the decedent.
There are often instances where it is impractical or difficult to have all heirs or devisees execute the deed. Title insurers will sometimes waive this requirement if there is no specific devise, the authority of the Executor or Administrator is clear and the devisees or heirs do not object to the transaction. Lawrence J. Fineberg, Handbook of New Jersey Title Practice, Chapter 53, Section 5327 (3d ed.). This consent can normally be obtained by way of the executor's or administrator's Affidavit of Title. If there is any question or suspicion, however, the consent should be directly obtained.
Judgments Against Heirs or Devisees
It can be argued that because title to decedent's premises passes to heirs or devisees by operation of law, that judgments against such heirs or devisees are liens on the premises. Clearly, if there is a specific devise, judgments against the specific devisee immediately attach to the devised premises. When there is no specific devise, the position of title insurers on the issue of whether judgments against heirs or devisees must be treated as liens on the decedent's premises, and whether the issue of heirs' or devisees' spousal marital rights must be addressed varies, depending on the facts.
There are a number of considerations the title insurer will look to in making this determination. Most significant is probably the passage of time. If more than one year has passed since the date of decedent's death, many underwriters will take the position that judgments against the heirs or devisees must be raised. As set forth in Lawrence J. Fineberg, Handbook of New Jersey Title Practice, Chapter 53, Section 5329 (3d ed.), other considerations are: whether there is any restriction on the executor's or administrator's power to convey, whether Letters Testamentary or Letters of Administration are still in effect, whether it is an arms length transaction for full consideration, whether the executor or administrator is the sole heir or devisee and whether the heirs or devisees are in possession of or exercise control over the realty.
In conclusion, the most significant issues with regard to decedent's estates to be dealt with in real estate closings are usually state and federal tax issues. In all instances it is critical to keep the title insurer closely advised and to seek guidance from the insurer as to underwriter standards and requirements.
This article is reprinted with permission from the JUNE 20, 2005 Issue of the New Jersey Law Journal ©2005 ALM Properties, Inc. Further duplication without permission is prohibited. All rights reserved.