Estate and Elder Law

Primary Tax Considerations in Planning for Succession to Family Homes

Estate planning for the succession to family properties requires careful consideration of a number of complicated, and sometimes conflicting, tax laws. In this Analysis, Nancy G. Henderson discusses primary tax considerations in estate planning for family homes. She writes:

     A significant assumption for purposes of this article is that there are federal estate and generation-skipping transfer (GST) taxes.

     A. Federal Estate Tax. For most clients, the primary impediment to a successful transfer of a valuable family home to children and grandchildren is the federal estate tax. The federal estate tax is imposed upon the cumulative fair market value of all of a decedent's assets held at death. Important in the context of planning for family homes is that, included in the decedent's taxable estate are not only assets legally owned by the decedent at the time of death, but also assets which the decedent may have given away from a state property law perspective, but over which the decedent held impermissible "strings attached" for federal estate tax purposes. Such "impermissible strings" include the right to retained use or enjoyment of transferred property without adequate consideration to the donee, the right to receive the income generated from transferred property, or the right to control the donees' beneficial interests in transferred property in a manner that is not limited to a reasonably definite standard. The decedent's taxable estate will also include assets transferred by others over which the decedent held a general power of appointment exercisable during life or upon death.

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     C. Gift Tax. The second most important tax imposed in connection with succession planning for family homes is the federal gift tax. Under current federal tax law, lifetime transfers of real property made out of detached and disinterested generosity (other than a transfer for full and adequate consideration in money or money's worth) will give rise to a federal gift tax unless a transfer qualifies for certain statutory exclusions or deductions. Among the available deductions are the unlimited gift tax marital deduction for transfers to U.S. citizen spouses and the unlimited gift tax charitable deduction for transfers to qualified charitable organizations. Also excluded from gift taxation are gifts of present interests in property, provided that the cumulative amount of all such gifts from one donor to one donee in any one calendar year does not exceed the amount of the gift tax annual exclusion, which is presently $13,000. Once a donor's cumulative gifts to a donee exceed the gift tax annual exclusion, the donor must begin to consume his or her lifetime applicable exclusion from gift tax, which presently shelters from gift taxation the first $1,000,000 of such otherwise taxable gifts. To keep the Internal Revenue Service apprised of the use of the donor's gift tax applicable exclusion, a gift tax return is required to be filed for any calendar year in which the donor makes gifts to which the applicable exclusion will apply.

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     E. Income and Capital Gains Tax. Transfers of real property present challenging income and capital gains tax considerations as well. While a lengthy discussion of these taxes is outside the scope of this article, there are certain income and capital gains tax issues that bear particular mention.

     First, family properties are often held for a long period of time and may therefore be highly appreciated. As a result, any strategy that contemplates intervivos gifts must balance the estate tax savings of the strategy against the loss of the basis step-up that would have been achieved had the property been held until the death of the owner. Further, any strategy that contemplates a sale of the property, other than to a sale to a defective grantor trust or a sale taking place during post-mortem administration (when the property has secured as new tax basis), will generate capital gains taxes and possibly the recapture of certain income tax deductions taken by the seller if the property was at any time held for the production of rental income.

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