We get a ton of calls from families who are sideways dealing with an inheritance. They are getting hit with unexpected taxes and all sorts of other issues.

 

This week's blog from our founder Harry Barth pulls the curtain on dealing with an inheritance...

 

When most families picture “getting an inheritance,” they imagine a simple transfer of wealth—funds appear, the house gets sold, life moves on. But in real life, inheritances are often a storm of legal, tax, and administrative landmines. And for married couples, those landmines can follow them into their marriage, their personal liability exposure, and even their long-term tax picture.

 

This is the story of Mark & Lisa, a married couple in their 40s whose inheritance from Lisa’s parents turned into a tangled estate case involving probate, outdated beneficiaries, appreciated real estate, and serious tax planning implications.

 

The Family Background

 

Lisa’s parents lived a classic American life:

 

• A primary home they bought 40 years ago (highly appreciated) – titled in their living trust
• A rental property they owned jointly (not in the trust)
• A $500,000 life insurance policy
• Dad’s IRA (a rollover from his old 401(k))
• Several investment accounts, some titled correctly in the trust and others not
  

 

They had a living trust, created years ago, but—like many families—it was never fully funded. Assets drifted outside the trust over time.

When Lisa’s father passed away recently, the gaps in the planning became painfully obvious.

 

Where Things Went Wrong: A Mixed-Bag Estate

 

1. The IRA Beneficiary Problem

 

Dad’s IRA listed his wife as sole beneficiary.

 

She passed away before him … and he never updated the form.

Result?

 

There is no living beneficiary, so the IRA defaults to the estate.

 

This means:

 

• The IRA becomes a probate asset (even though IRAs normally avoid probate).
• The estate must take distributions under the 5-year rule, creating accelerated income taxation.
• The funds lose the ability to stretch RMDs over the daughter’s life expectancy.
  

 

A single outdated beneficiary form can cost a family hundreds of thousands in lost tax benefits.

 

2. The Rental Property Problem

 

The rental property was owned jointly by the parents, not in the trust.

 

When Dad died:

 

• Mom already died previously, so there was no surviving joint tenant.
• Title does not automatically pass to Lisa.
• The property must now go through probate, even though a living trust existed.
  

 

A core misunderstanding:

 

Joint ownership and trusts do not automatically coordinate.

If the asset isn’t titled in the trust → probate is required.

 

3. The Life Insurance Policy

 

Good news:

 

The $500,000 life insurance policy avoids probate and pays directly to the listed beneficiary.

 

But here’s the twist:

 

The beneficiary was listed as the trust—which is good.

 

But because not all assets were properly coordinated, Lisa and Mark will still deal with:

 

• Trust administration rules
• Trustee accounting
• Creditor periods
• Potential state-level reporting
  
  

4. The Primary Home

 

The home was in the trust.

 

This means:

 

• It avoids probate
• It transfers smoothly through trustee administration
• It receives a full step-up in basis (and potentially another step-up if the trust was joint and both parents died)

 

This step-up alone may save the couple tens of thousands when they sell.

 

The Hidden Cost: Probate Is Coming

 

Even though a living trust existed, two major assets (the IRA and the rental property) must go through probate.

 

What probate means for the couple:

 

• 9–18 months minimum
• Attorney fees based on statutory percentages
• Court supervision of asset transfers
• Delays in accessing funds and property
• Public record of family assets
  

 

So now Lisa and Mark are stuck handling:

 

1. A trust administration
2. A probate proceeding
3. Estate taxes and income taxes
4. Asset protection issues on inherited rental property
   

 

This is common when families have a trust but fail to maintain it.

 

Real Tax Issues the Couple Must Navigate

 

1. The Double Step-Up in Basis Question

 

The home and rental property may get:

 

• One step-up if the first spouse died
• A second step-up when the second spouse died
• …but the rental property was not in the trust nor titled as community property.
  

 

That means:

• They may lose a full second step-up
• Capital gains exposure increases
  

 

This becomes a tax-planning puzzle.

 

2. IRA Taxation

 

Because the IRA has no beneficiary:

 

• It goes to probate
• The estate must withdraw funds under the 5-year rule
• All withdrawals are ordinary income
• No stretch IRA for Lisa
  

 

Depending on IRA size, this could push the couple into a much higher tax bracket.

 

3. Life Insurance Proceeds

 

Life insurance is usually income tax free, but:

 

• It increases the size of the trust estate
• It may impact state estate tax thresholds
• It must be reinvested properly or placed into protective structures

 

Asset Protection Issues for the Couple

 

1. Rental Property Liability

 

Once Lisa inherits the rental:

 

• It becomes her personal asset
• Any lawsuit relating to the property is now her personal liability
  

 

Best practices:

 

• Transfer property into a properly structured LLC
• Make sure it is coordinated with the living trust
• Review umbrella and landlord insurance

2. Marital Property Considerations

 

Since Lisa inherited the assets, they may be considered her separate property—but only if:

 

• They are not commingled
• The couple maintains proper titling
• We create protective structures (LLCs, irrevocable trusts, insurance coordination)

 

Failing to do this could expose the inheritance to future:

 

• Lawsuits against Mark
• Business liabilities
• Divorce claims
• Creditors

 

Case Study Wrap-Up: What Mark & Lisa Are Now Doing

 

Working with our office, here are the steps they’re taking:

 

1. Opening probate for the IRA and rental property
2. Navigating trust administration for all trust-titled assets
3. Retitling the rental property into a new LLC to protect Lisa personally
4. Fixing unresolved beneficiary designations on their own accounts
5. Establishing a new asset-protection trust to house inherited liquid investments
6. Running tax projections to minimize the IRA’s tax hit
7. Updating their own estate plan based on the new wealth and risk profile

 

Inheritance isn’t just receiving assets.

 

It’s managing risk, taxes, and legal exposure.