Zaremba Center for Estate Planning & Elder Law

What Are the Rules for Death and Capital Gains Taxes?

Step-up in basis doesn’t depend on whether or not you pay state or federal estate or inheritance tax on the real property.

It’s not uncommon for a family to have a cabin or vacation home in another state. It’s also not uncommon for the parent and owner of that vacation home to ask if the out-of-state vacation home receives a step-up in basis when his or her children inherit it.

The IRS says that to determine if the sale of inherited property is taxable, you must first determine your basis in the property. The basis of property inherited from a decedent is generally one of the following:

• The fair market value (FMV) of the property on the date of the decedent's death.
• The FMV of the property on the alternate valuation date, if the executor of the estate chooses to use the alternate valuation.

They refer to the Instructions for Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. The IRS suggests that for information on the FMV of inherited property on the date of the decedent’s death, you should contact the executor of the decedent’s estate. The agency also notes that in 2015 Congress passed a new law that, under certain circumstances, requires an executor to provide a statement identifying the FMV of certain inherited property to the individual receiving that property.

When a person passes away, the property he or she owns or controls, like what’s included in their taxable estate, will be valued as of the date of death. Children who inherit the property will take the property or asset with the date of death value as his or her basis.

The step-up in basis doesn’t depend on whether or not you pay state or federal estate or inheritance tax on the property.  However, if you file a federal estate tax return, the value of the property reported on the return must be the same as the value reported by the children for the property as their basis in reportable transactions.

If a person only owns part of the real property at his or her death, it’s possible only that portion will get a step-up in basis.

With the owner living out-of-state, it’s important that the owner and the heirs understand the so-called "exit tax." For example, when New Jersey residents sell their homes and prepare to move out of state, they must pay a standard tax rate on the profit from the sale. This tax must be paid when you move, not when you’d usually file a state income tax return.

Reference: nj.com (July 24, 2018) “Cost Basis for and Inherited Vacation Home”

 

Splitting the Lake Cabin Among the Kids

A parents’ well-meaning bequest could wind up destroying family relationships.

By giving a gift of the family cabin, mom and dad see years of their children enjoying family reunions at the lake but the reality may be quite different. The issue is that some of the children might want to cash in their share of this valuable asset, and others may not.

Some of the kids may be attached to the family vacation home and want to keep it. If possible, the best solution is a buyout among the siblings. That’s not as simple if finances don’t allow it, and the sentimental siblings are forced to sell, resulting in hard feelings. Another option is to put the vacation home in an irrevocable trust to remove it from the estate.

In addition to a need for cash, one heir may reside too far away to enjoy the home regularly, another heir may have a spouse who doesn’t want to use the vacation home, or another heir may be unmarried without children and has no need for a large vacation home. Family discussions should take place while original vacation homeowners are still alive and healthy, in order to eliminate a great deal of frustration and stress.

Remember, a vacation home sale doesn’t qualify for the $250,000 capital gain exclusion (or $500,000 for married couples filing jointly) that can apply to the sale of a principal residence. A large gain on a vacation home might be taxed at the top 20% rate on long-term capital gains. There’s also the 3.8% surtax on net investment income, as well as the potential for state income tax. But maintaining the vacation home and leaving it to the heirs as an inheritance, doesn’t create an income tax bill because there’s step-up basis to the date-of-death value. This wipes out the capital gains tax on prior appreciation.

When the kids are older, family discussions while both parents are alive can help make estate planning decisions that everyone likes. The kids might want to share the house and maintain it. If one child isn’t as financially secure as the other, he may want to inherit cash rather than the property. If that’s honored by the parents, they can state in their estate plan that one child will get the house and the other will get an equivalent value of other assets. The real estate appraisal can take place at the time of death. Frequently, one child purchases the family home from the estate of the parents, and other siblings buy their own vacation home—perhaps with their own inheritance. This makes everyone happy.

Some families will put the vacation home into an irrevocable trust to remove it from their estate.  However, this can result in capital gains issues for the children in the future. They’ll lose the basis step-up. One option to discuss with an attorney is to decant the trust—or move the assets to a new trust with different terms.

Speak with a qualified estate planning attorney to see what options are best for your family situation.

Reference: Financial Planning (May 23, 2017) “Save clients from tax pitfalls, family strife when passing on that lake cabin”

 

 

Is It Time for Your Trust Review?

Estate tax laws change regularly, which means that estate planning methods that were once a great idea are no longer advisable for many people. One example of that has to do with the estate tax, capital gains taxes and trusts.

Bypass trusts used to be one of the best estate planning devices for many married couples. In these trusts, one spouse funds the trust with an amount just below the estate tax exemption. When that spouse passes away, the trust is then used for the benefit of the heirs, with the rest of the estate passing to the surviving spouse. Consequently, this approach lowered the size of the surviving spouse's eventual estate and lessened the estate tax burden for the married couple. However, as Kiplinger's Retirement Report points out in "Old Trusts Create Tax Issues for Heirs," estate tax laws have changed significantly since the time when many of these trusts were created.

The estate tax exemption is far higher than it used to be, and spousal portability now allows a married couple to double its estate tax exemption. The problem for irrevocable bypass trusts is that assets in them do not receive the step up basis for purposes of the capital gains tax. What this means is that for many families, efforts to get around the old estate tax laws are actually creating a greater tax burden now and they would be better off without the bypass trusts entirely. This is just one example of why it is important to review your estate plan with an attorney every few years. You want to make sure your estate plan is always ideal given the current estate laws, not older out of date laws that may not be relevant to your unique circumstances. All that noted, every family situation is different. For example, in blended family situations, the irrevocable bypass trust may be the appropriate solution to avoid disinheriting your own children!

Make no estate plans or changes to your current estate planning without the prudent guidance of a qualified estate planning attorney. You can learn more about this topic as well as other strategies on our website under the tab entitled: estate planning in Virginia. Be sure you also sign up for our complimentary e-newsletter so that you may be informed of all the latest issues that could affect you, your loved ones and your estate planning.  However, proper estate planning is not a do-it-yourself project.  Why not call us for a complimentary consultation at 757-259-0707. 

Reference: Kiplinger's Retirement Report (October, 2015) "Old Trusts Create Tax Issues for Heirs"

 

Minding Your Cost Basis Will Reduce Your Tax Burden

The cost of being lazy about cost-basis elections seems particularly high right now, given that the markets have generally been trending upward as the new regulations have gone into effect.

Investing and taxation can be tricky things, especially if you have been investing for some time. This can get even trickier when you transfer assets to loved ones or contemplate doing so. Taxation hinges on a few fundamental numbers, one of which is the cost basis. Given some interesting changes to the law governing cost basis, you may need to rethink your plans.

If you have investment accounts, then you likely are aware of some of the changes that have begun to take effect and will continue to roll out through 2013. One of the most obvious changes was addressed in a Morningstar article titled “Beware the Default Method for Cost-Basis Elections.” Are you aware of the difference between the old style of cost basis election and the new possibilities your brokerage firm or mutual fund company can offer?

Essentially, the old system of electing a cost basis was typically in the hands of the investor since they had to track and record their own cost basis on various investments. This meant averaging out the cost basis when selling various stocks at tax time. Now the cost basis is directly reported to the IRS from the firm/broker.

Companies tend to offer the default means of reporting, but since information is going directly to the IRS, this also means there is enough information for specific-share identification in the cost basis election. The Morningstar article offers some interesting math to support why this actually can be advantageous for the crafty planner.

The bottom line is that any trimming you can safely accomplish can secure more favorable capital gains taxation. Why? Because this cost basis carries over into another magic taxation number, the stepped-up basis, when investment assets are transferred. In short, small numerical changes add up and may affect your overall wealth-transfer planning.

You can learn more about this topic as well as other strategies on our website under the tab entitled: estate planning in Virginia. Be sure you also sign up for our complimentary e-newsletter so that you may be informed of all the latest issues that could affect you, your loved ones and your estate planning.  However, proper estate planning is not a do-it-yourself project.  Why not call us for a complimentary consultation at 757-259-0707.  

Reference: Morningstar (March 26, 2012) “Beware the Default Method for Cost-Basis Elections”

 

The President’s New Plan for the Middle Class

Tax and economic reforms are on the President’s agenda for 2015 as he seeks to close what he terms “unfair loopholes that are only available to the wealthy and big corporations” (perhaps another inappropriate use of the term “loophole”).

Forbes recently detailed some of the key proposals from the President in its article titled “President's New Tax Proposal Would Hit Wealthy, Benefit Middle Class.”  The highlights include these provisions: 

Eliminating stepped up basis. The President says that this is “the single largest capital gains tax loophole.” He proposes to eliminate stepped up basis at death, in which heirs are allowed to use the date of death value of capital assets instead of the decedent’s actual basis for capital gains calculations. 

Raising capital gains and dividend rates. In order to spur investment activity, the capital gains and dividends rates have been decreased over the past 30 years. The President’s plan would up those rates to 28% for high-income taxpayers. 

A new tax credit for double-income families. The President proposes providing a tax credit of up to $500 for families with two working spouses equal to 5% of the first $10,000 of earnings for the lower-earning spouse in a married couple. The maximum credit would be available to families with incomes up to $120,000, with a partial credit available up to $210,000. 

Upping child care tax incentives. The President proposes to increase the child care tax credit, or the dependent care tax credit, to $3,000, but only for middle class families with children under five. 

New education tax benefits. Combining some of the existing education tax benefits is part of Obama’s strategy. A move that would conceivably permit more students up to $2,500 in tax breaks each year over five years. The Lifetime Learning Credit and the tuition and fees deduction would be cut and replaced by an expanded American Opportunity Credit (AOC). The refundable part of the AOC would also be increased. 

You can learn more about this topic as well as other strategies on our website under the tab entitled: estate planning in Virginia. Be sure you also sign up for our complimentary e-newsletter so that you may be informed of all the latest issues that could affect you, your loved ones and your estate planning. 

Reference: Forbes (January 17, 2015) “President's New Tax Proposal Would Hit Wealthy, Benefit Middle Class”

 

 

Easing the Tax Bite When Selling Your Business in Virginia

A lot of small business owners accelerated sales of their companies into 2012 in anticipation of the new higher tax rates for 2013, but for those who are thinking of selling now, don’t despair. “There are things you can do to minimize—or with the right set of facts—eliminate taxes.”

Is any of your personal wealth tied up in your business? Well, for some people, the business is their current life, both in time and wealth. Consequently, it can be an especially rude shock to see so much of that wealth snatched away in taxes paid upon the sale of that business.

The tax bite is a bit bigger these days, too.

So, whatever you can do to shelter the business sale from taxation can mean a world of difference for your retirement and even for the whole family. Turns out there are more than a few important tools at your disposal.

First, why is the tax bite bigger these days? The American Taxpayer Relief Act of 2012 (ATRA) befriended a new surtax added through Obamacare and this friendship brought the capital gains tax up from last year’s 15% to 20%, or even a whopping 23.8% for some earners. But wait, there’s more.

An extra provision of ATRA is set to add yet another 1.2% as of the new year. Then add state taxes. It just adds up, and that is really bad math for you.

So what are some tools and ways to lessen the tax bite? Depending on your business, your needs, and your timeline, consider three tested tools discussed in a recent Forbes article titled “Selling Your Business? 3 Ways To Cut The Tax Bite.” 

While you will want to read the original article, here are the three ways:

• The ESOP Plan,
• The Qualified Small Business Stock Plan, and
• The C-to-S Corporation Conversion Plan.

Essentially, the plan (as far as capital gains taxes) is to either find a way to defer the taxation until you leave assets to your heirs (to secure the capital gains eliminating stepped-up basis), to fall under a discounted category, or to actually change the form of the business so as to skate right below that low ceiling.

There are a few more ways of doing any one or all of these steps cleanly and efficiently, especially with those with the foresight to plan well in advance.

You can learn more about this topic as well as other strategies on our website under the tab entitled: business planning in Virginia. Be sure you also sign up for our complimentary e-newsletter so that you may be informed of all the latest issues that could affect you, your loved ones and your estate planning.  

Reference: Forbes (September 6, 2013) “Selling Your Business? 3 Ways To Cut The Tax
Bite”

Avoiding The 2013 Capital Gains Gotcha in Virginia

Last year’s historically low capital gains tax rate of 15% is, well, history, but there are still ways around the new higher rates that went into effect Jan. 1st. The 15% top capital gains tax rate went up to 20%. High income earners have to tack on another 3.8% (the net investment income surtax). Look at this before year-end if you want to avoid a surprise capital gains tax bill when you file your tax return next April.

Did you know there's a new tax bite effective January 1, 2013? For example, unless you have been paying close attention to capital gains and your expected tax hit for 2013, then you might not realize the pain until tax season. For those in the know, however, there is still time to beat the capital gains tax in 2013 and beyond.

For some ideas to consider before it is too late, take a look at a recent Forbes article titled “How To Beat The Big 2013 Capital Gains Tax Hike.”

The Great Capital Gains Tax Hike of 2013 was essentially the double-pronged effect of the eclipse of certain tax cuts mixed with a brand new surtax. More specifically, the gains tax was allowed to bounce from 15% to 20%, and Obamacare added to the pain with a new 3.8% surtax to high earners. If you are doing the math, then that equates to a new rate of 23.8% for many (a near 60% increase from the year then ended).

So how do you beat it?

Here are 11 strategies to consider, according to Forbes:

1. Invest in your primary residence.
2. Manage your tax bracket.
3. Harvest losses.
4. Gifts to family members.
5. Gifts to charity.
6. Feed retirement accounts.
7. Open a 529 college savings account.
8.  Buy and hold.
9.  Move to a tax-friendlier state.
10.  1030 exchanges.
11.  Charitable trusts.

Each of these strategies has merit.

Nevertheless, the key is to evaluate them (and others) with your professional advisors in the context of your medium and short-term financial and estate planning goals.

The tax “tail” should never automatically control the planning “dog.”

You can learn more about this topic as well as other strategies on our website under  the tab entitled: estate planning in Virginia.  Be sure you also sign up for our complimentary e-newsletter so that you may be informed of all the latest issues that could affect you, your loved ones and your estate planning.

Reference: Forbes (September 13, 2013) “How To Beat The Big 2013 Capital Gains Tax
Hike”