ALBUQUERQUE, N.M. — Today I will tell you something not to do. Obviously this could encompass many things. For example, taking the “five for $5” family discount at Bubba’s bungee jumping off of the Great Smoky Mountains although it appears Bubba has only one elastic cord.
Well thank goodness my kids were a little smarter than I was on that one, but today I’ll stick to tax planning ideas to avoid. And one in particular because it was featured in a leading financial publication. The headline said that an old planning idea for the wealthy had been revived.
I thought I had all the old ideas compartmentalized in my head — that was always my excuse for the inability of new ideas to squeeze in. But I must confess while I heard of this idea I have never had a client even remotely contemplate it.
Alright Mr. Negativity, you say, just tell us the idea and we can decide whether we want to be part of a good old-fashioned revival.
When you inherit property your tax basis is adjusted to the fair market value (FMV) of that property. So if you own land with a FMV of $3 million and a tax cost of $1 million, your death can be an income tax bonanza for someone who inherits that property.
The lucky heir’s tax basis is adjusted to $3 million and they can sell and avoid paying the IRS anything. You, by contrast, would have paid (probably) $476,000 in federal tax and $49,000 in New Mexico tax with a sale during your life.
But let’s say that you own this land and you’re not about to die. In fact you are a healthy 50-year-old triathlete. But your Dad is 86 and not doing well. His estate is about $1 million. And he may not live more than two to three more years.
So here’s what the leading financial publication says you should do — reviving what apparently others unknown to me also did.
You give the land to Dad. You have to file a gift tax return but will pay no tax because the gift is not substantial enough. Dad takes your $500,000 tax basis. But he has no plans to sell. In fact he changes his will to provide that you will inherit the land upon his death.
Before we address some sticky family issues that may arise, let’s dispatch with the potential tax problem. Dad must live more than one year after the gift. If he does not, you will not be entitled to the special basis adjustment when you inherit the land that you previously gifted to him.
So let’s say that Dad is good for the two to three years. You then inherit your land. The FMV at his death becomes your tax basis — even if it is more or less than the $3 million value at the date of the gift.
Dad owes no estate tax and the inheritance is free of the income tax. You sell the land following the inheritance and have no capital gain. You now have the sale proceeds and the IRS does not have its $476,000 or the NMTRD its $49,000.
So what could possibly go wrong?
I could probably end the column right here. Why? Because you don’t have to be a tax expert to start listing what might go wrong.
I could ask you to all send in your potential family disasters. I might hear something new. I learned years ago my family didn’t corner the market on crazy, although we kept the shelves stocked pretty well.
So let me get the list started. Dad decides to sell the land. Dad becomes a victim of elder fraud and donates the land to the Committee to Repopulate Planet Mustafar. Dad remarries and likes his new family better than yours.
Your brother, founding partner of Dewey Cheatam and Howe law firm (I know the name is stolen but the sentiment is what matters) convinces Dad to execute a power of attorney giving him complete authority over Dad’s assets.
Dad lives 13 more years. Look, I’m just suggesting it might not be what you wanted — don’t grimace at me. And so on, and so on. Still interested in this revival?
Jim Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at email@example.com.