Most people who quote Benjamin Franklin's famous words about the only sure things in the world being death and taxes are unaware that he was making a point about the prospective resilience of our then-newly established Constitution. Nonetheless, the Constitution held up, as have taxes, even those following death.
More than one potential tax may be due when assets are distributed after the owner dies. The Estate Tax is the one most people think of and one of the most hated levies. But, interestingly, it doesn't apply to many taxpayers. Before the passage of the Tax Cuts and Jobs Act, the threshold for imposition of the federal estate tax was $5.49 million. Now it is $12.06 million, including the gross estate, adjusted taxable gifts, and specific exemptions. Unless Congress extends the provisions of the TCJA (due to expire in 2025), the amount will revert to $5.49 million then.
For estates with a value exceeding the $12.06 million threshold, taxes are imposed in increasing amounts up to 40%. Estate taxes, however, are paid by the estate, not the beneficiaries of the estate.
How Does the Taxpayer's Investment Strategy Impact the Estate's Value and Tax Status?
Taxpayers who own investment property may have more than one goal when selling properties. For example, if the asset has appreciated, the investor may seek to defer the tax on the capital gain as they move from one property to another.
Using a 1031 exchange to facilitate the transaction may potentially accomplish this goal. The investor may also divide their assets into portions that are more easily distributed to their intended heirs. Equally important, by deferring the realization of the gain until after their demise, an investor can bequeath the property to their heirs at a stepped-up value, relieving the recipient of the tax liability.
Similarly, exchanging real property into a Delaware Statutory Trust (DST) may ease the distribution to future heirs and can potentially help manage the tax consequences for the estate.
What Is a Beneficiary?
An estate beneficiary is a person or entity who will inherit the assets of the person who dies. Typically, the beneficiaries are designated in a will or trust. Heirs may owe inheritance taxes, which are levied against the individual recipient rather than taxes against the estate's value as a whole. As noted, the estate pays the estate tax, which is determined by calculating the estate’s value and subtracting the liabilities. Six states have inheritance taxes, while twelve states plus the District of Columbia have estate taxes in addition to the federal estate tax.
What Is the Portability Exemption?
The portability of the estate tax exemption has reduced the number of taxpayers to pay estate taxes. The modification to federal estate taxes was created in 2010 as part of the Tax relief, Unemployment Insurance Reauthorization, and Job Creation Act. If one spouse in a married couple dies and their estate does not need all the available exemptions, the unused portion is transferred to the surviving spouse. When that second spouse later dies, they can use that transferred portion plus their own exemption. If a spouse is a joint owner of assets, they may not be using any of the exemptions when the first spouse dies, leaving more for use when the second one passes and maximizing the availability of the exemption. If the first spouse’s will distributes assets to other beneficiaries, portability won't have as significant an impact. It's important to note that most states don't allow portability of their estate tax exemptions.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. Costs associated with a 1031 may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. No public market currently exists and one may never exist for interests in a DST. DST programs are speculative and suitable only for Accredited Investors who do not anticipate a need for liquidity or can afford to lose their entire investment.