For more on this and other useful insights you can use with clients, check out the latest issue of Current from the Nationwide Retirement Institute.
Q. If a client gifts land to their children while the client is alive, what are the tax consequences to the children if they sell a portion of the land?
A. We see this question frequently in planning with farmers. The short answer is that the child selling the land is likely to see significant capital gains tax. The reason for the tax is due to the low basis in the property. When gifting, the property does not receive a step-up in basis; the property carries over the basis from the previous owner. There may also be applicable gift taxes that should be considered.
Q. What if the client gifts the land as an inheritance?
A. The owner of the land can draft a will (or other document) that passes ownership of the land to the desired party at their death. Doing so will allow for the land to receive a step-up in basis to fair market value. Therefore, when the land is sold, the capital gains tax will typically be reduced.
Q. Are there different tax implications to gifting with estate planning documents such as wills, trusts or deeds?
A. It depends. Generally, these types of planning documents apply only at the death of the holder of the assets. Therefore, the asset that is passed via one of these documents will see a step-up in basis. However, there are some trusts and deeds that are funded by gifts or given to the desired party from the holder of the assets while they are alive. Gifting while alive means the assets will have a carryover basis (the basis that the former holder of the asset had). In that case, different levels of taxation could apply either at the original holder’s death or when the new holder of the asset sells that asset.
Q. If someone sells depreciated equipment that was gifted to them, what are the tax consequences?
A. This scenario is a potential tax bomb. Gifted assets carry over the basis of the former owner of the asset. If that asset was fully depreciated, the basis is likely to be $0. For example, say a piece of equipment was fully depreciated in year one via IRC Section 179. If the gift recipient sells the asset, they may owe a recapture tax. A recapture tax allows the Internal Revenue Service (IRS) to collect taxes on financial profits from the sale of assets. Recapture is taxed at ordinary income rates, not capital gain tax rates, so take care when selling gifted depreciated assets.
Q. What planning strategies can be used when there are capital gains from a sale of an asset?
A. There are several ways to alleviate the tax burden a client could face, but the best thing an individual can do is talk to a tax professional prior to selling the asset. To mitigate taxation, the tax professional may recommend the use of a trust to help plan for taxes owed. They may also suggest a qualified opportunity fund as a way to plan the tax burden.