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Funds’ ‘payable on death’ designation trumps will

Q: My sister passed away in March and I became the beneficiary of several bank accounts that she had set up with a “payable on death” designation. The transfer as a beneficiary was made last year after her husband passed away. Her will names two charities for a designated gift and also my two children for $5,000 each. I am to receive everything else. The three bank accounts total about $110,000 and I am working on selling her house, which should net about $180,000. Is the $110,000 something that I can treat as my “own,” or does the money first have to be used to pay the charities and my children? If it is mine, then do I have to pay tax on it?

A. The $110,000 is yours. I do not know if you have transferred the funds to your name yet, but you should be able to do so by presenting a death certificate to the financial institution holding the funds.

A payable on death designation will override the will, so the funds held in a POD account will transfer to the beneficiary upon the death of the account owner.

When your sister first set up the POD designation there was no gift made to you as the beneficiary. A POD designation can be changed by the owner at any time before death, so simply naming a beneficiary is not a completed transfer.

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There are some exceptions to the beneficiary’s ownership of a POD account following the owner’s death. For example, the funds are part of the decedent’s estate and may need to be sued to satisfy claims of creditors of the estate.

The funds available when the house sells would be used to satisfy the bequests in the will to your children and to the charities. Any remaining funds would be yours.

The will must be probated to prove its validity. From the information that you provided, it will be only the funds from the sale of the home that will pass by the directives in the will.

New Mexico also allows real property to transfer to a named beneficiary by use of a transfer on death deed. You didn’t indicate the house had one, but readers may be interested in such a designation.

Like a POD designation, a TODD may be changed any time before the property owner’s death. This means that no gift occurs when the deed designation is first made.

If any readers have questions or interest in TODD designations, the New Mexico State Bar Association has an excellent discussion of the issues on their website. Google “New Mexico Bar and TODD.”

You will not have to pay tax on an inheritance regardless of the form it takes.

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Q: Is there any limit on how many properties that you can deduct property taxes for? I’m asking because I know that you can deduct interest on only two properties – your home and one other residence. I am considering buying six investment lots that are contiguous, and I wonder if it would be better to have them combined into one lot if there is a limit on the property tax deduction.

A. There is no limit. You are allowed to deduct property taxes on any number of properties. The only requirement is that the tax be based on the value of the property.

I need to add that your description of the tax rules for deducting interest is not complete. There is a two-property limit for deducting interest on personal use property, such as your home and a vacation home.

This two-property limit applies because the interest would otherwise be personal in nature, and personal interest is generally not deductible. Interest on a loan to acquire your principal residence and one other residence is an exception to that restriction.

Investment interest and business interest are deductible without regard to the number of properties or loans to which the interest relates.

So to clarify – if you purchase six vacation homes you can only deduct interest on a loan to buy one. But property taxes are deductible for all.

If you buy six investment lots, the interest on an acquisition loan and the property tax is deductible for all six.

Jim Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. Reach him at jimhamill@rhcocpa.com.


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