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Follow-up course on basics of tax basisFollow-up course on basics of tax basis

Troy Schneider

March 29, 2023

3 Min Read
close-up of man's hands as he signs contract
ASK QUESTIONS: Even the basics of tax basis do not seem so basic. But remember, the most successful people are the ones who ask good questions. Richard Drury/GETTY IMAGES

In the previous Legal Matters column, attorney Tim Halbach explained the “stepped-up” tax basis rules. Just to refresh, tax basis is the amount paid for an asset. Tax basis is lowered by the amount deducted from the purchase price against taxable income on the individual’s tax return, which the IRS calls depreciation.

As Halbach explained, after someone dies, an individual’s remaining tax basis in an asset steps up (or steps down) to a date-of-death fair market value.

As a follow-up to last month’s article, here’s how tax basis plays out in some basic estate planning tools.

Gifts vs. inheritances. Receiving an asset during life for no money (a gift) is different than receiving that same asset for no money upon death (an inheritance). If a person receives a gift, he or she receives the remaining tax basis from the person who gave the gift. In other words, when a lifetime gift is made, the remaining tax basis “carries over” from the old owner to the new owner. In contrast, as explained earlier, when a gift is made after death, the remaining tax basis steps to a date-of-death value.

Transfers and basis. Basis is important in farm business planning. When an asset is sold, the seller calculates the taxable gain by taking the sales price minus the basis. If assets are transferred and the individual assumes a portion of the transferor’s debt, then it is treated as if the transferor sold the transferee the asset for the amount of debt assumed.

As an example, suppose farm parents give a tractor to their child that has a remaining tax basis of $20,000. However, the parents still owe the bank $50,000 for the tractor, which loan is assumed by their child. As a result of this transaction, the parents will have $30,000 of gain to report on their tax return.

Trusts and basis. The use of trusts in farm estate planning is very common. It is important to remember that aside from income tax, there is another area of taxes called gift and estate tax. Simply put, the IRS will tax transfers of assets made by a person while they are alive (gifts) or after they die (estate).

The current tax rate is 40%. However, the tax only needs to be paid when the gift and estate transfer amounts together exceed $12.92 million.

Assets that are owned by an individual for gift and estate tax purposes will receive a stepped-up basis for income tax purposes. In general, there are two types of trusts that can be established while someone is alive: a revocable trust and an irrevocable trust.

A revocable trust can be revoked or amended while someone is alive. Assets placed into a revocable trust are treated as owned by the person who set up the trust (called the grantor) for gift and estate tax purposes. As such, assets placed into a revocable trust will receive a new basis upon death for income tax purposes.

An irrevocable trust is a trust that cannot be revoked or amended. Assets placed in an irrevocable trust are deemed given away by the grantor and usually do not receive stepped-up basis upon the grantor’s death. An irrevocable trust is sometimes drafted to protect assets, such as for nursing home Medicaid purposes. In this type of trust, provisions can be drafted so the grantor is no longer the owner for Medicaid purposes; however, certain powers can be retained so he or she is the owner for gift and estate purposes, which then allows for stepped-up basis.

Even the basics of tax basis do not seem so basic. However, always remember, the most successful people are the ones who ask good questions.

Schneider is a partner in the agricultural law firm of Twohig, Rietbrock, Schneider and Halbach. Call him at 920-849-4999.

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