With Potential Tax Changes Looming, Should You Revamp Your Estate Plan?

The American Families Plan, a plan that redirects $1.8 trillion dollars into education, healthcare, childcare, and more, is gaining traction in Congress. But how does President Biden propose to pay for these investments into American families?

One proposal involves restructuring taxes on inherited wealth, something to watch closely if you expect to pass on significant or even moderate assets to your children and/or grandchildren.

The proposal would target generational wealth transfers by increasing estate taxes and creating capital gains taxes on inherited real property exceeding $1 million ($2.5 million for a married couple).

An increase of estate taxes could simply mean that the threshold for exempted assets would be lowered. For example, right now estate taxes of 40 percent apply only to those with a value of $11.7 million or more, or $23.4 million in joint assets. Under the new proposals, the estate tax would increase to 45 percent, and the estate tax exemption amount could drop to as low as $3.5 million per individual or $7 million in combined assets. In other words, the tax rate itself would increase a bit, and many more estates would be hit with tax.

As the law stands currently, heirs of inherited real estate can defer taxes on the gains until they sell the property. These taxes are calculated on a “step up basis” which adjusts the “cost basis” to the value on the date of the prior owner’s death.

Under the proposed new plan, real estate over the proposed exemption amount ($1 million or $2.5 million for a married couple) would be taxed on the differed or “built-in-gain” based on the difference between the home’s original value or “cost basis” and the date of death value treated as a capital gain.

In some situations, this new tax could create a tax burden for heirs who would otherwise prefer to keep the property. Those in a position to leave real estate to their heirs might wish to consider restructuring their estate plans at this time. Generally speaking, individuals with a net worth of $2.5 million or more and married couples with over $5 million should pay close attention to this issue now.

Options to reduce or avoid this tax do exist. For example, a second home could be gifted before the owner’s death via a qualified personal residence trust. The original owner is still legally allowed to use the property for a determined number of years.

Reducing the taxable amount by claiming costs for improvements is another potential strategy. After performing renovations, those costs can be claimed against the gains to reduce the tax. However, meticulous records must be kept.

Finally, family limited partnerships or limited liability companies could provide an avenue for efficiently passing wealth in certain situations.

These planning tools can be complicated. They should not be contemplated or executed without the guidance of an estate planning attorney and tax professional. Call our office to schedule an appointment, and we can walk you through your options and help you draft a new or revised estate plan that works for your situation.

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