[vc_row][vc_column width=”1/1″][vc_column_text]In most cases, it is a bad idea to transfer assets out of a person’s name just before death. One of the reasons is due to a loss of “step up” in income tax basis as a result of the transfer. Any assets that are owned (whether in an individual’s name or in an individual’s living trust) will receive a “step up” in income tax basis as a result of being part of the decedent’s taxable estate.
Assume, for example, that you bought one share of Apple stock when it was selling for $100 per share. Let’s then assume that at the moment of your death, the stock was selling for $500 per share. If you die with that share of stock in your name (or titled in your living trust), the share will receive a “step up” in its income tax basis, meaning it gets a new income tax basis equal to $500 per share.
Had the one share of stock been sold the day before you died, there would have been a $400 gain on the share of stock because you purchased the stock for $100, and you sold it for $500. Also, if you gift that share of stock to your son the day before you die, the son then takes a “carryover basis” which means his income tax basis would equal yours at the time of the gift. That is, you purchased it for $100, you gave it to him with a $100 basis, and if he then sells it, he will be subject to a $400 gain. Again, if your son had received the stock under your will and sold the stock any time thereafter, he would have zero gain, assuming the stock remained valued at $500 per share.[/vc_column_text][divider line_type=”No Line” custom_height=”40″][vc_text_separator title=”Step up basis and the family farm” title_align=”separator_align_left”][vc_column_text]This same example works with a family farm. Assume, for example, that your grandmother and grandfather purchased a family farm many years ago for $50,000. Assume now that the farm is worth $550,000. If the family rushes in and has Granddad (or his power of attorney) transfer the farm to the kids or grandkids just before he dies, the kids or grandkids will receive the farm with the original income tax basis of $50,000. This means when the grandfather dies and the property is sold, there will be a $500,000 gain on the sale of that property. Had the family not rushed in to get all the assets out of Grandfather’s estate, the farm would have been subject to the “step up” in basis rules, with a new basis of $550,000 when it passes out of Grandfather’s estate to the kids or grandkids. Doing nothing, therefore, saves the family from paying tax on a gain of $500,000.
What if there was a retained interest in use of the farm as a part of the transfer? Granddad transfers the property to his children but continues to live in the home up until his death, rent-free. The retention by Granddad of the right to live on the farm he gave away is a “retained” interest in the farm, which the IRS says pulls the farm back into Granddad’s taxable estate.
Another example of a retained interest may be where Granddad continues to receive income off of some of the crops or rental of the farmland. Such retained income or interest in the profits from the farming operation would be a “retained interest” and arguably allow for the property to be included in the estate under this retained interest exception.
One reason to take advantage of the step up in basis rules is to get a step up in depreciable assets related to the farm. There are lots of items related to a farm (fences, roadways, outbuildings, barns, etc.) that have long been fully depreciated down to a zero basis. Working with the step up in basis rules will give those depreciable items a new income tax basis and effectively allow for a restart on the depreciation to those farm improvements.[/vc_column_text][/vc_column][/vc_row]