Written by David Fisher
There are many truisms regarding the Old West. John Wayne will always ride to the rescue. You never want to be on Jimmy Stewart’s bad side and sometimes even on his good side. Don’t mess with Texas, Robert Mitchum, or Glenn Ford. Errol Flynn will get the girl and yours as well if you’re not careful. When Ms. Kitty says jump, you do. Don’t challenge James Garner to a card game or a gun fight. Regardless of who plays Custer, the result always seems to be the same. I want Gary Cooper in my foxhole and if it’s big enough, Randolph Scott is welcome as well. And last but certainly not least, Jack Elam isn’t going to win a beauty contest anywhere in our universe. Or any other universe.
There is another well-known truism with farm and ranch owners and that is that high taxes tend too often to prevent the sale of a great property. Well, help is on the way and this time, it’s not John Wayne but rather it’s me. That’s right I am coming to the rescue with the help of the great ranch and farm brokers found in LAND magazine and soon high taxes will no longer be the obstacle to selling a great property as they currently are.
When selling a great property, the following taxes apply to the hard earned sales proceeds, the capital gains tax of 20%, state taxes where applicable, depreciation recapture at 25% and the Obamacare tax of 3.9%. Depending on the state, the seller can pay between 25% to 40% in taxes on the gain of the sales proceeds.
There are a number of common situations where our tax deferral strategies can be quite effective. For example, in the last LAND Magazine issue, I briefly mentioned the stepped up basis as a way to avoid taxes when the land owner wants to pass on the property to their heirs. Let’s assume that the land owner will be alive for at least 10-20 years. Our tax deferral strategies in fact may be an great option, but let’s look a little closer.
The first concern when dealing with tax law in general is our politicians especially when the law seems to benefit the taxpayer. No group is better at finding additional taxes than Congress and although the stepped up basis is in the tax code, who knows for how long? It may stay for another generation or it could be changed in the next administration. After all, in 1775, it was John Adams who said that, “In my many years, I have come to the conclusion that one useless man is a shame, two is a law firm, and three or more is a Congress.”
Second, no one has a crystal ball as to what the market is going to do over the next decade. I vote that it keeps going up but no one listens to me. In a decade or two, the property could double in value or could actually decrease and could be less than it is today. In the meantime, the property continues to be an illiquid asset.
Third, depending on the value of the property, the larger potential tax remains a potential problem and that is the federal estate tax. Assuming that the federal estate tax applies, the property owners estate over $10 million is going to be taxed at 40–45% and that could be devastating to the estate. And, by the way, Congress wants that tax paid sooner than later.
So are there any alternatives to using the stepped up basis as a tax planning tool to solve these concerns? Of course, there is. That’s why I’m riding to the rescue!
Our tax deferral strategies may be a great option to the stepped up basis and here’s why. First, changing the stepped up basis is probably going to receive far more attention by Congress because someone there will convince themselves that this is just another loophole for the wealthy and must be changed. Having said that, let’s assume that Congress doesn’t care about the stepped up basis because they have far more important issues to deal with, like raising their own salaries and voting on laws that they exempt themselves from, so are there any other reasons to consider an option other than the stepped up basis?
Absolutely. It was just a few years ago that real estate values hit a bubble causing values to decrease dramatically and many property owners were blindsided by the downturn. Like the stock market, it takes years for values to recover. What if, however, your property could increase in appreciation by 5–6% every year regardless of the real estate market conditions AND, instead of that appreciation being on paper, it’s in your checking account. Every year. And that appreciation can continue as long as your heirs would like.
But it could get even better. Using the stepped up basis will avoid capital gains tax but the federal estate tax still has to be paid. Your estate would have to use 100 cent dollars so the property may have to be sold anyway to pay the tax and with little or not benefit to the heirs. Consider this option. Instead of potentially having to use 100 cent dollars to pay the federal estate tax, why don’t you use tax deferred dollars. That’s correct. By using one of our tax deferral strategies, you can use the deferred taxes to pay the federal estate tax.
Let’s say that using our strategies, you were able to defer $2 million in taxes for as long as you and your heirs would like. Let’s assume that your federal estate tax is $4 million. You can use some of the deferred taxes to possibly provide enough estate liquidity to pay the federal estate tax. Imagine using tax money that instead of disappearing at the IRS will pay most if not all of your federal estate tax liability. Being able to accomplish this would make Jimmy Stewart smile at least for a moment but still couldn’t help Jack Elam anywhere in any universe.
Our tax deferral strategies can defer taxes in a variety of situations. We are more flexible than a 1031 and when several owners want to sell a property, we can provide any of them that want to defer taxes with a strategy to do so. We may be able to take debt in a mortgage over basis situation and turn that debt into equity. The opportunities are endless and we can go into more detail in future issues.
Best of all, the wonderful brokers in this magazine are familiar with many of these ideas so work with them and tell them to call me so I can come to the rescue. I may not be on a horse but will have plenty of horsepower. Some guy named Will Rogers once said,”Always drink upstream from the herd.” Just because the herd chooses to pay the capital gains tax doesn’t mean that you have to follow them. Best wishes until the next time we visit.