This column first appeared in the San Antonio Express News on January 29, 2018.
Dear Mr. Premack: My 95-year-old mother owns a large piece of ranch land. The value per acre is fairly high, and her tax adviser years ago told her to start gifting “undivided interests” each year worth $14,000 to each of the children. They said that this would reduce the value in her estate, and when she dies there would be less estate tax due. I was wondering, now that the estate tax is due only when the estate is $11 million or more (and her estate is around $7 million) does she need to keep making these annual gifts of her land? – C.N.
The original plan was sound, but the law has changed, so you are wise to ask if her gifting program should be modified. Until the law changed on January 1, 2018, her $7 million estate would have been subjected to an estate tax of approximately $600,000 upon her death. Every time she gifted a $14,000 share of her land, the gift reduced the eventual estate tax by $5,600. That can add up with many gifts over many years.
But since the Tax Cuts and Jobs Act increased the exemption to $11 million the estate tax is not an issue. (The law is scheduled to reverse course in 2025, reducing the exemption again to $5.5 million, but a) it is possible that Congress will decide to extend the exemption as they did in 2010 and 2012, and b) it is possible that your mother will not live until 2025.) Additional gifts to reduce estate taxes is no longer necessary.
In fact, the gifting program may actually trigger an increase in taxes to which the family is exposed. The issue now is the “free step up in basis” for capital gain taxes. Her ranch land is an appreciated asset. Any portion that she gifts to her children loses the step up in basis – that is, when the children sell the land after her death, they will be subject to capital gain taxes at the same basis as your mother instead of the land’s market value on the date of her death.
Here is an example: assume the ranch is worth $2 million (out of her overall $7 million estate) and assume that she had enough years to gift that entire $2 million to the children.
Under the old law, the gifts would have reduced her estate tax to $0, but when the children sell the land they would have to pay capital gain tax of about $400,000. Without gifting, her estate tax would have been about $600,000. With gifting, her estate tax would have been $0, but capital gain taxes would be $400,000. The gifts would have a net savings to the family of $200,000.
Under the new law, her estate tax is zero. The gifts were not needed to get that reduction; it would be zero even if mother still owned the land upon her death. Yet because of the gifts, when the children sell the land there is a $400,000 capital gain tax. So, under the new law, the gifts actually cause a tax increase of $400,000.
Consider then, the possibility of gifting the land back to your mother. This would use up part of the children’s lifetime gift tax exemption, but they would pay no tax on the transfer back to mother. Now that she owns the entire ranch again, her taxable estate again hits $7 million. When she dies, there is $0 estate tax because of the 2018 Tax Cuts and Jobs Act. The children inherit the ranch and get a full step up in basis for capital gain tax. When they sell the ranch, they pay no capital gain tax on the value at the time of her death. No estate tax, no capital gain tax means saving $400,000. Definitely discuss this with your CPA and Estate Planning Attorney to see if returning the gifts would be the right approach for your family.
Paul Premack is a Certified Elder Law Attorney with offices in San Antonio and Seattle, handling Wills and Trusts, Probate, and Business Entity issues. View past legal columns or submit free questions on legal issues via www.TexasEstateandProbate.com or www.Premack.com.
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