Positioning your estate plan to protect your assets requires prior planning with a legal professional. One of the most important goals is maximizing realized gains on the property. Capital gains tax, a tax on the appreciation of the property at the moment of sale, is one of the principal expenditures that all property sellers incur. However, real estate owners who plan ahead of time with an attorney well-versed in real estate and tax law can reduce or postpone their capital gains tax liability. Here are three key things you should know when strategizing around the capital gains tax.
1. Structuring Ownership Through Trusts to Utilize Primary Residence Benefits
An experienced estate planning attorney can structure a trust in a way that is independent from the grantor for estate tax reasons while still being held by the grantor for income tax purposes. This key distinction allows the grantor to be considered the “owner” of the trust for income tax purposes.
Therefore, transactions between the trusts and the grantor are “disregarded,” which means that assets can be sold or exchanged with the trusts, and the trusts can pay interest on low interest notes owed to the grantor without triggering any income tax consequences. This is especially valuable if the trust will hold one’s primary residence. If the residence is sold, the afforded status serves to protect the beneficial capital gains tax treatment.
2.) Beneficiaries Enjoy a Stepped-Up Basis
If an estate property is sold for a higher price than which it was purchased, capital gains tax may accrue. Unfortunately, this often severely affects the individual who inherited the property. Beneficiaries of a relative’s home could be obligated to pay capital gains tax if they sell the residence. If the property is sold at a loss, the individual selling it may be able to claim a capital loss deduction. However, this is not frequently the case because investments, particularly real estate, have historically increased in value.
Luckily, the IRS applies a measure to such scenarios called stepped-up basis. The home’s base value is adjusted to reflect the fair market value at the time of death. A beneficiary would only be subject to capital gains tax if they sold the house and profited from the stepped-up valuation. Whether the assets are real estate, money, or stocks, a step-up in basis at death can significantly reduce the beneficiary’s tax responsibilities after the grantor’s death. If this provision is not used, the beneficiary’s inherited assets will be subject to significant taxation.
3. The Benefit of Forethought for Home Sales
A primary residence sold for profit will incur reduced capital gains tax. A single person can exclude $250,000 from their taxable gain before capital gains tax is calculated. A married couple can exclude $500,000 from their taxable gain. When benefits of taxation of primary residence need to be incorporated into succession planning, a trust can be structured to utilize these tax benefits, while allowing shift of control to the next generation and creating an asset protection structure. Some forethought may be beneficial if you plan to sell the property during your life and use the exclusion of $500,000, or when you intend to leave the property to your heirs and allow them to take a step-up in basis when they are ready to sell the property.
Lawyers in NY, NJ, and FL
Beress & Zalkind PLLC is a boutique law firm devoted exclusively to the practice of Trusts and Estates, Corporate/Business, Real Estate, and Tax law. With this personal attention and high level of service, we can understand our clients’ needs and help them achieve their goals in their business and personal endeavors. Contact us to work directly with legal advisors dedicated to protecting your interests. We are admitted to practice in NY, NJ, and FL.
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