As long as I’ve been doin’ this, leaving your real estate empire to heirs upon your demise had a preordained happy ending. The real estate investor who passed, did so knowing his kids (usually) could sell some or all of his properties without paying a cent in capital gains taxes. He knew this, and what was even better, relied upon this due to IRC Section 102. Section 102 is fairly wordy, but in essence it’s the hook on which taxpayers have been hangin’ their hats for a long, long time.
In a nutshell it (102) says the heirs take the property(s) tax free. Good enough — as far as it goes. But, you ask, what if I wanna sell it? What happens then? On what does the heir then calculate their capital gain? Is it a capital gain? Will the heir have any tax liability?
Section 1014 of the IRC, in a nutshell says no. It’s called ‘stepped up basis’. The property is valued at Fair Market Value at the time of death. This acts to effectively raise the basis from whatever it may have been to current market value, more or less. Because of Section 1014 any rise in value of the property in question which occurred during the decedent’s lifetime may never be taxed. I know, sounds to good to be true, but I’ve dealt with dozens of heirs over the years, and except for the amount of sales price exceeding the value at death — their was no tax liability incurred by the heirs.
The Old School of real estate investment brokers used to say without deviation — “Defer ’till ya die.” If I heard it once, I heard it a thousand times. Since those early days they’ve learned how to leverage other parts of the code, often avoiding the necessity for a tax deferral strategy, but you get the gist. The code, simply put, provides strong incentive for taxpayers to defer capital gains from Day 1 to the grave.
Ah, but there’s about to be a huge Gotcha!
Beginning right after ya finish kissing your sweetheart at midnight of New Year’s Eve 2009, 1014 will be terminated, ended, sliced and diced if you will. In 2001 the Economic Growth and Tax Reconciliation Act (EGTRRA), had this ‘sunset provision’ in it from the outset. Now, the heirs will take the property with a revised ‘carryover basis’ rule. The property will then receive a basis equal to the adjusted basis of the property in the hands of the decedent OR the fair market value — whichever is less.
Know how I’m always pounding the theme of folks gettin’ into trouble as a direct result of the answers to questions they didn’t know to ask? This particular answer, this newest ‘gotcha’ from our favorite folks on Capitol HIl begs several questions 90% of investors don’t know to ask — and is a prime example of why I bring up all those pesky questions never asked by most investors.
BawldGuy Takeaway: If you’d prefer leaving your estate without it being molested by Uncle Sam, there are strategies available to you. But they need to be part of your Purposeful Plan a whole lot sooner than just before ya say your final goodbyes. It is called a Plan, right?
BawldGuy Axiom: The Golden Rule says, “Those with the gold make the rules.” Those who can print whatever money they need, AND control the tax code, also make the rules. They can change ‘em any time they want, too.
Tax deferred exchanges have their place for sure. Lord knows I’ve done more than my share, as I stopped counting at around 200 or so. But it’s just another tool to be used when appropriate and nothing more. The continued worship of the 1031 exchange is about to have some lethal unintended consequences for folks who didn’t know the right questions to ask — or when to ask ‘em. Be careful out there. Enough said.
Let’s talk. 619 889-7100 or email me. I’m pretty good at promptly responding. Have a good one.
Related posts:
- A Strategy For A Recent Heir — Or What To Do With Grandpa’s Cash And House
- Real Investors Are Looking Beyond Next Year
- Adjusted Basis: It Ain’t Just ‘Buy Low & Sell High’ For Real Estate Investors
- Ending 30 Year Ban — Never Say Never — The Lani & Benn Show — Ditchin’ Weight
- Some End Of The Year Thoughts For Current and Future Real Estate Investors
About BawldGuy
Realizing that he would soon be gone from this world one day, Moody said to a friend, “Someday you will read in the papers that D.L. Moody of Northfield is dead. Don’t you believe a word of it.
“At that moment I shall be more alive than I am now. I shall have gone higher, that is all–out of this old clay tenement into a house that is immortal, a body that sin cannot touch, that sin cannot taint, a body fashioned like His glorious body. I was born in the flesh in 1837; I was born of the Spirit in 1856. That which is born of the flesh may die; that which is born of the Spirit will live forever.”
I’m not sure if I can tie that quote directly to this post. But none-the-less I thought it interesting enough to share.
“…sometimes they come from left field.”
As a PK I can connect it easily.
Let me see if I have this straight. The estate tax was supposed to sunset in 2010 as well, then pop back up the following year with the original $1,000,000 limit on excluded estate value. Congress, of course, was going to “fix” that pop up problem. Since there was to be no estate tax and therefore no taxable event, there would be no reset of the basis. Seemed like a reasonable trade to me. Now, as an heir, you can give up 45 percent or more of the value of the property over a certain amount (probably $1,000,000) in estate tax, and NOT receive a stepped up basis for the assets? That’s going to make real estate a heck of a lot less popular asset class. Time to get those NAR lobbyists to work!
AI — Very rarely does NAR ever succeed with anything of real import in Washington. Real estate will not recede as a favored asset because all the other assets fair even worse.
Also, real estate has strategies available which allow investors to significantly obviate much of these changes.
I’m with you though — they never seem to figure our that bleeding the golden goose is a finite strategy.
Bawldguy — As I was sending a copy of your blog entry to family and friends I found this on the net:
It’s possible however that HR436, the Certain Estate Tax Relief Act of 2009 may be passed to erase the effects of EGTRRA. It repeals Sections 541 and 542 of EGTRRA, which were set to go into effect in 2010. Thus, it reinstates Section 1014, which provides a step up in the basis of assets includable in a decedent’s estate for estate tax purposes and repeals Section 1022, which provides for carry-over basis.
HR436 is in committee at this point, so no knowing if it will become law.
Regards,
Hawk
Geez, I thought NAR was responsible for the definition of “real estate professional” for depreciation write-off purposes. Now who should I blame for that carve in/carve out?
Tim — Since the current atmosphere in D.C. is decidedly tilted against both creation of and keeping wealth, I wouldn’t bet the ranch on HR436′s survival in any positive form.
NAR’s history has been terrible when pitted against any real power — even when the right side of the aisle had anything to say about it. I remain hopeful, but have no real expectation of the bill’s success.
AI — NAR has one agenda: Keeping their valuable data private. The rest is white noise.
Hey, great article, after this comment I’ll send it on to my investors.
_ I never count on the NAR doing anything of value to directly effect anyone but the mass NAR ego.
Hey MaryAnn — Thanks for passin’ it on.
Wish NAR’s record was different than it is, but it speaks for itself, doesn’t it? Very sad.
Hi Bawldguy,
This will be addressed by Congress before the end of the year, so it will be a mute point. The unanswered question will be what tax exempt limit to place on the inheritance. $3.5 and $5.0 million are the ones most frequently mentioned right now.
Hey William — I keep reading the same thing, but can’t allow myself to put much faith in it. It makes far too much sense, which as we both know, puts it in major jeopardy these days.
I’d sure rather believe your take on it for sure.
Don’t be a stranger, OK?