Wealth transfer strategies is a pretty generic term to describe an important part of your financial planning strategies. While normally I try to keep things a little “lighter” in my blog, sometimes some good information is passed my way that is a bit more in-depth. As the election approaches, now is a good time to get ahead of some of the possible impacts the election can have on your portfolio and estate planning needs. We’ve had a pretty steady past four years under the current administration, but come January 1, things could be considerably different.
Some General Advice
With a push by the Democratic party to return federal estate taxes to their historic norms, taxpayers need to act now before Congress passes legislation that could adversely impact their estates. Currently, the federal estate and gift tax exemption is set at $11.58 million per taxpayer. Assets included in a decedent’s estate that exceed the decedent’s remaining exemption available at death are taxed at a federal rate of 40 percent (with some states adding an additional state estate tax). However, each asset included in the decedent’s estate receives an income tax basis adjustment so that the asset’s basis equals its fair market value on the date of the decedent’s death. Thus, beneficiaries realize capital gain upon the subsequent sale of an asset only to the extent of the asset’s appreciation since the decedent’s death. If the election results in a political party change, it could mean not only lower estate and gift tax exemption amounts but also the end of the longtime taxpayer benefit of stepped-up basis at death. To avoid the negative impact of these potential changes, there are a few wealth transfer strategies it would be prudent to consider before the year-end.
Intrafamily Notes and Sales
In response to the COVID-19 crisis, the Federal Reserve lowered the federal interest rates to stimulate the economy. Accordingly, donors should consider loaning funds or selling one or more income-producing assets, such as an interest in a family business or a rental property, to a family member in exchange for a promissory note that charges interest at the applicable federal rate. In this way, a donor can provide a financial resource to a family member on more flexible terms than a commercial loan. If the investment of the loaned funds or income resulting from the sold assets produces a return greater than the applicable interest rate, the donor effectively transfers wealth to the family members without using the donor’s estate or gift tax exemption.
Swap Power for Basis Management
Assets such as property or accounts gifted or transferred to an irrevocable trust do not receive a step-up in income tax basis at the donor’s death. Gifted assets instead retain the donor’s carryover basis, potentially resulting in significant capital gains realized upon the subsequent sale of any appreciated assets. Exercising the swap power allows the donor to exchange one or more low-basis assets in an existing irrevocable trust for one or more high-basis assets currently owned by and includible in the donor’s estate for estate tax purposes. In this way, low-basis assets are positioned to receive a basis adjustment upon the donor’s death, and the capital gains realized upon the sale of any high-basis assets, whether by the trustee of the irrevocable trust or any trust beneficiary who received an asset-in-kind, may be reduced or eliminated.
Example: Phoenix purchased real estate in 2005 for $1 million and gifted the property to his irrevocable trust in 2015 when the property had a fair market value of $5 million. Phoenix dies in 2020, and the property has a date-of-death value of $11 million. If the trust sells the property soon after Phoenix’s death for $13 million, the trust would be required to pay capital gains tax on $12 million, the difference between the sale price and the purchase price. Let us say that before Phoenix died, he utilized the swap power in his irrevocable trust and exchanged the real estate in the irrevocable trust for stocks and cash having a value equivalent to the fair market value of the real estate on the date of the swap. At Phoenix’s death, because the property is part of his gross estate, the property receives an adjusted basis of $11 million. If his estate or beneficiaries sell the property for $13 million, they will only pay capital gains tax on $2 million, the difference between the adjusted date-of-death basis and the sale price. Under this scenario, Phoenix’s estate and beneficiaries avoid paying capital gains tax on $10 million by taking advantage of the swap power.
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If any of the strategies discussed above interest you, or you feel that potential changes in legislation will negatively impact your wealth, I strongly encourage you to schedule a meeting with my office at your earliest convenience and definitely before the end of the year. We can review your estate plan and recommend changes and improvements to protect you from potential future changes in legislation.
If you would like to know a little more about financial planning and estate planning, you can click here for a free guide. If you’re ready to get started, call my office to set up a Legal Strategy Session and we can discuss the best option for your situation – (877) AMAYERS.