By, Shirley Farmer, Attorney at Law
The information provided in this article is intended to give a general overview of the topic and is not intended as legal advice. For information specific to your situation, please talk with your estate planning professional.
Article #14, Tax Issues and Estate Planning
There are many factors to research when creating your estate plan, and consideration for the tax ramifications of your choices is a key issue. Each person’s circumstances will be unique, and it is important you talk with a tax professional to get information specific to your particular estate plan. Various forms of tax can apply to your estate, and this article will look at a just three of the more common tax issues impacting today’s estate planning in Oregon: Estate Tax, Gift Tax, and taxes on real property acquired through inheritance or gift.
Estate Tax. Not all states have a state estate tax above and beyond the federal estate tax, but Oregon is one state who still does. Currently, if the gross value of your estate is more than one million dollars ($1,000,000) at the time of your death, there may be estate tax owed to the state of Oregon. This is considerably lower than the federal estate tax, which kicks in for estates valued at more than $5.43 million for 2015. The value of your estate is determined based on the gross value of your assets. The gross value includes everything from real estate (the value of your property, not just the equity), retirement accounts, life insurance proceeds, and can include property you own in a revocable living trust – this can add up to more than you might think!
As with all taxes, there are exemptions and exceptions. There are also estate planning tools to help limit the tax liability, which is why it is important to talk with both a tax professional and an estate planning professional to learn what your options are.
Gift Tax. Many people have heard of the federal “gift tax,” though most are unfamiliar with how it actually works. You are currently allowed to give away (“gift” or transfer) assets with fair market value of $14,000 or less per year, per person without having to file a gift tax return. You can gift more than $14,000 total, so long as each individual receives less than $14,000. For example, if you have five grandchildren, you could gift $14,000 cash to each grandchild in 2015 and still not have to file a gift tax return. The gift tax exemption amount changes regularly, and has been increasing in recent years.
If you were to give any one individual assets worth more than $14,000 in any given year, you will need to file a federal gift tax return. This does not mean you necessarily owe any gift tax, you just have to file the return. Currently, a person can gift up to $5.43 million over the course of their lifetime before gift tax is actually owed.
Taxes on Sale of Real Property. This one is a bit more complex, and this section is only an overview of the issue. Often the largest asset in an estate is real property – your home or land. Whether your beneficiary who will receive the real property intends to keep and live in the property or sell the property can have an impact on how and when you want to pass along the interest in the property to them.
Many people seek to add a child’s name to the deed of their real property as a means of estate planning. Along with liability issues (a topic for another article), there can be major tax ramifications for this choice. First, this can constitute a transfer of an interest in the asset requiring a gift tax return be filed. Also, gifting an interest in the property this way versus letting it pass to the beneficiary via a Will after your death can make a big difference in the taxes owing from sale of the property by the beneficiary. Key factors are the cost basis for the real property and when the beneficiary intends to sell it.
The cost basis of the property impacts the tax owed on the profits of sale when a property is sold. If your beneficiary will be selling the real property after your death, they could pay a lot more in taxes on the sale if you add their name to the deed instead of letting them inherit the property after your death. For example, if you purchased the property 10 years ago for $150,000, that is your basic cost basis for the property (there are things that can contribute to raising or lowering that cost basis, but we’ll stick to the simple figures for this article). Say the property is now worth $450,000. If you sell the house and it has been your primary residence, your taxable portion of the proceeds is the difference between the sale price and the cost basis, so the profit of $300,000.
There is currently a federal tax exemption of $250,000 for an individual ($500,000 for a couple) if the real property has been your primary residence for two of the five years prior to sale. So, if your taxable portion is $300,000 and you are a couple, you would not owe tax on the sale as the total is below the exempted amount. If you are an individual, you would owe tax but only on the $50,000 above the tax exempt amount.
If your beneficiary inherits the property at your death such as through provisions of a Will, they inherit the property with the cost basis at the value of the property at the time of your death. This is called a stepped-up cost basis. However, if you add a beneficiary’s name to the deed of the property prior to your death, they do not get this stepped up cost basis and get stuck with the original cost basis. Using the above figures as an example, say instead of you selling the property you pass away and your son inherits the home and he decides to sell it. If your son inherited the property through a Will, his cost basis will be the value at the time of your death, or $450,000. If he then sells the property for that amount, there would not be tax on the sale as no “profit” difference between the cost basis and sale price. If, however, you had instead added his name to the deed before your death he does not get that stepped-up cost basis from inheritance, and his cost basis would be the same as yours leaving him owing taxes on all that profit from sale.
This has been a very brief overview with very basic examples. There are many intricacies and variations, and tax laws change regularly. Talk with your estate planning and tax professionals to develop a plan that is right for you!