Consider the Federal Inheritance Tax Changes in Estate Plan
Tax Law Impacts Property Valued at more than 1.3 Million
As of January 1st, 2010, the federal inheritance tax has been reduced to zero. Effectively, Congress did not act quickly enough to enact a new law in time to change Bush's 2001 law allowing estate tax to be reduced gradually over time and then being reinstated at pre-2001 level of 55% for estates above $1 million.
If you have not been following the estate tax debacle, it may be about time to pay attention. A caveat in the 2010 law means inherited real property valued at more than $1.3 million could trigger tax bills for beneficiaries. Unfortunately, this means that some heirs who previously would have been exempt may owe capital gains taxes on inherited assets.
This controversy of the estate tax issue dates back to Bush's first tax cut in 2001 that phased down the tax from 55% down to zero in 2010. Although that 10-year tax law was to expire in 2011, the expectation was that once the estate tax was gone for even one year, it would never return or at the very least Congress would extend the 2009 terms.
In 2009, the first $3.5 million of an estate generally was excluded from federal taxes with a top tax rate of 45%. The federal estate tax was scheduled to temporarily disappear in 2010, before returning in 2011 at an even higher 55% rate. During 2010 without an estate tax, all estates over $1.3 million would be subject to a 15% capital gains tax. Law makers are attempting to change that along with the 2010 inheritance tax rate, and are discussing making laws retroactive to January 1, 2010.
LOSS OF STEP-UP BASIS
Under previous law, inherited property was given a full stepped-up basis for tax purposes -- the value of property on the date of death was considered the “cost” basis for the beneficiary. Under current law, if a parent paid $300,000 for a home and the value of the home on the date of the parent’s death was $1.5 million only $1.3 million can receive step-up treatment. Therefore, the beneficiary inherits the decedent’s cost-basis above $1.3 million (or, $200,000 in this example). Surviving spouses can step-up an additional $3 million. That’s going to create a taxing situation for thousands of moderately well-off families in 2010.
If Congress passes retroactive legislation, prior court cases suggest that restoring the estate tax is legal. If Congress takes no action, the top rate on long-term capital gains will remain 15% in 2010, but will automatically rise to 20% in 2011. The estate tax will then have a $1 million exemption and the tax on the remainder will be 55%.
With estate and capital gains taxes expected to return in 2011 (at the unfavorable rates that applied 10 years earlier), heirs may find a §1031 Exchange a viable option for deferring capital gains taxes upon inheritance of real property.
More 1031 information for those properties that may be in a short sale or foreclosure situation.