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Thursday, April 10, 2008

ENCUMBRANCES CAN DRAMATICALLY ALTER ESTATE PLAN RESULTS

When a testator specifically leaves real estate or other property under his estate planning documents, and that property is encumbered by debt, it is important that the estate planner determine the testator's desires as to the debt and make proper provision for it. This is because the treatment of that debt at death can dramatically impact both the recipient of the property and the residuary beneficiaries of the estate. For example, if the recipient of the property is to receive it free and clear of the debt, then the estate will have to pay off the debt with other estate assets. This payment will usually directly decrease the assets left for the residuary beneficiaries. Alternatively, if the debt is not paid off, the net value passing to the beneficiary receiving the property can be substantially diminished.

This effect of these issues was illustrated in a recent Florida appellate case. In the case, a decedent left 3 family farms to one of his sons. At the time of death, the farms were encumbered by over $240,000 in debt. The decedent's remaining property was to be divided among 5 beneficiaries (one of which was the son who received the farms). The Last Will had no specific provision as to whether the debt should be paid off by the estate, although it did provide that all of the decedent's legal debts should be paid.

During the course of administration, the estate paid off the debt, so that the son received the farms free of debt. One of the residuary beneficiaries sued, claiming that the payment was not authorized.

Fortunately for the residuary beneficiaries, Florida law has a provision on point which provides “[t]he specific devisee of any encumbered property shall be entitled to have the encumbrance on devised property paid at the expense of the residue of the estate only when the will shows that intent” and that “[a] general direction in the will to pay debts does not show that intent.” FS Section 733.803. Based on this statute, the payment of the debt by the estate was held to be improper.

Whether this is what the testator intended is unknown. Therefore, to make sure that the testator's intent is properly implemented, planners need to specifically inquire of the testator what is desired, and if needed, make specific provision in the Last Will if the default result under Florida law will not accomplish this intent. Even when it is intended that the debt not be paid from the residuary as per the default scheme under the statute, a specific statement to that effect may still be helpful so that the decedent's heirs are comfortable that the statutory scheme was specifically desired by the testator.

In re: Estate of James Ollis Woodward a/k/a James O. Woodward. BRIAN WOODWARD, Appellant, v. ELLEN C. SMITH, as personal representative of the estate of James Ollis Woodward, Appellee. 2nd District. Case No. 2D07-713. Opinion filed April 9, 2008.

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