Estate Step-Up in Basis in Jeopardy

January 23, 2015 07:42 AM

The current tax law allows a step-up in value of almost all assets at death to fair market value. For farmers, this law comes into play with the transfer of farmland.

money-risk-gambleAs part of President Obama’s recent State of the Union address, he announced various tax-related measures to help the lower and middle class and close certain "trust fund" loopholes. Paul Neiffer, CPA with CliftonLarsonAllen and author of The Farm CPA blog and Top Producer column, says this loophole is primarily the ability to step-up assets to fair market value at death.

“With the current proposal, any time you transfer property from you to your heirs—during life or at death—President Obama wants to tax that as if it was sold at fair market value,” Neiffer told attendees of the 2015 Top Producer Seminar.

How will that affect farmers? Neiffer provides this example:

Assume farmer John owns 1,000 acres of ground that he purchased in 1960 for $100,000. That ground is now worth $10 million. When Farmer John passes away, his heirs will be able to sell the ground for $10 million and pay no income tax.

Under President Obama's proposal, farmer John's heirs would still have an income tax basis of $100,000. In addition, President Obama wants to increase the top capital gains tax rate to 28%.

Let's assume that farmer John owes the 40% estate tax on the $10 million of value. In addition, let's assume farmer John lives in the state of Washington with a top estate rate of 19%, which lops off another $1.9 million. However, this would reduce the federal estate tax liability by $760,000. We now have total estate taxes of about $5.14 million.

The heirs all live in California and elect to sell the farmland for $10 million. This results in about $2.8 million of federal tax plus about $1.3 million of California tax. Let's call it $4 million.

The bottom line is $5.14 million of estate taxes and $4 million of income taxes. On $10 million, the heirs net about $900,000 or less than 10%.

While this example is the worst-case scenario, Neiffer says, it’s likely that the heirs would be able to add the estate taxes paid to the income tax basis of the property (perhaps not the state estate tax). That would reduce the income tax liability by a bit more than a $1 million.

Neiffer says this estate tax law change was tried many years back and the administrative issues were immense. “The chances of this passing with Republican control of the House and Senate is somewhere between slim and none, but it is always wise to know when you might be considered a ‘trust fund’ loophole,” he says.


View a PDF of Neiffer’s Top Producer Seminar presentation: Tax Tips for 2015

Read Neiffer's blog: The Farm CPA


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