Low Basis versus Estate Taxes

Written by Michael Baron on . Posted in Equalization

Hi Michael: I have a question for you. We have quite a bit of land with little or no basis in the property. Our tax person told us if we pass this to our children they will receive a stepped-up basis in the land – if they farm it for three years. Would an irrevocable trust be the way to go? How does the new estate tax proposal change how we should be planning? – Low Basis.

Dear Low Basis: Estate taxes have always been based on the fair market value or appraised value of the assets held within your estate. The current amount you can pass without estate taxes is $5,490,000 Unified Credit per person or almost eleven million dollars per couple.

Upon your death(s), your estate will be appraised and all added up to come to a total. If your estate(s) are less than the Unified Credit, your children will receive a stepped-up basis in the property and there is no condition they farm for three years or, for that matter, have to farm at all. If they sell the assets later on for the same amount as the FMV at the time of death, they could do so without paying any capital gains taxes.

Some people have been told the children receive a stepped-up basis if they use a trust. This depends on if it is a revocable or irrevocable trust. A revocable trust – as you retain power over the assets until your death and is included in your estate at FMV – will receive stepped-up basis – the same as a will.

An irrevocable trust set up during your lifetime and receiving assets prior to your death has two tax considerations. One, as you ‘gift’ the assets to this irrevocable trust, you cannot exceed the Unified Credit amount of $5,490,000 per person or the gift taxes will equal the estate taxes.

The assets themselves – as they were a lifetime gift and no death occurred – are valued within the trust at your original basis. Not what they are worth today, not what you used for a ‘gift’ to move the assets, but the actual amount your originally paid for these assets. Upon your death, the assets pass to your children at your original basis and if they sell these assets, they will have very high capital gains.

There is a new idea sweeping around called a Delaware Trust. This involves finding someone who’s estate would not have estate tax issues and is relatively the same age as you – making them the beneficiary of your trust – and upon their death, the children would receive a stepped-up basis. In other words, you’re using someone who has no estate tax issues and using their Unified Credit. These transactions are all protected within different trusts moving around.

Estate taxes are always one side of the coin in estate planning, however. What happens if this person you’ve borrowed the Unified Credit from ends up in a long-term care facility and is owing hundreds of thousands of dollars in care costs when suddenly them become the beneficiary of your trust? Sure, when they die, the kids will get a stepped-up basis without paying estate taxes – of what’s left over if this person had health issues.

These type of ‘ideas’ get passed around every few years as one side tries to find a way to dodge taxes while IRS waits them out for a few years and, under current law, can disallow them upon your death. You may think you have hit on the perfect solution (LLC’s, LLP’s, Delaware trust, etc.) but IRS doesn’t have to accept your tax plan when you die – they can disallow it.

The new tax plan proposed states there would be no more estate taxes and family farms and small business would receive an exemption of up to $10,000,000 per family on capital gains.

Of course, the devil is in the details and would a farmer who sold his farm qualify for this exemption when he’s not going to be a farmer anymore by selling his farm? How long do I have to be a farmer to qualify? When I die and my children receive the land and they sell, do they get the $10,000,000 exemption because I farmed? Wouldn’t my family have been better off getting a stepped-up basis rather than having to pay estate taxes over and above $11,000,000? Long-term, could my capital gains be more than my estate taxes?

The answer is: We don’t know. Washington has been full of new ideas painted in broad strokes so we’ll see when they get it all figured out!

Michael Baron is not an attorney. Information given through written, verbal, or electronic means by Michael Baron or Great Plains Diversified Services, Inc. is not to be construed as legal advice. An attorney, tax advisor, or other registered advisor is needed for the completion of the estate planning process. An attorney must be consulted for legal advice and the drafting of legal documents.