With all the talk about potential changes to estate tax laws, I thought it would be a good idea to go back to the basics and discuss stepped-up basis.
When a person passes away, his or her assets are transferred to the beneficiaries in multiple ways. Most common is intestate (without a will), will, trust, joint ownership and beneficiary designation (life insurance, IRA).
In my experience, most farmers have a will or trust set up. Upon death, the executor/trustee typically gets an appraisal of assets to determine fair market value and see if an estate tax return is required. In some instances, an estate tax return may be filed so the surviving spouse can get the deceased spouse unused exclusion, commonly referred to as "portability."
When certain assets transfer at death, they receive a stepped-up basis. This means the beneficiary receives a basis in the inherited asset equal to the fair market value on the date of death (or alternative valuation date). Farm assets such as land, equipment, livestock, inventory (including growing crop based on state case law) and interests in partnerships are subjected to a stepped-up basis.
Why is stepped-up basis important in farming? Simply put, it provides a huge tax savings (not deferral). If you have an heir who wants to dispose of assets, he or she can sell and pay little or no tax on the proceeds. In farming, heirs often receive land as an inheritance that was typically acquired by gift or has little basis. Stepped-up basis allows the heirs to sell the land and pay little or no tax on the proceeds.
This is particularly beneficial when a nonfarming heir sells land to a farming heir. The nonfarming heir can sell to the farming heir at a discount since the proceeds are tax-free. Stepped-up basis also allows for the farming heir to redepreciate assets and receive basis in growing/harvested crops. This could be a tremendous tax benefit.
One often overlooked benefit of stepped-up basis involves capital accounts. Many farms are structured as partnerships or LLCs. Because of tax avoidance, farmers often take accelerated depreciation and defer income. The result is often a negative capital account (a topic I have written about several times). When the basis in the partnership is stepped up, the negative capital account goes to zero.
If you did not have stepped-up basis, the heir would inherit the deceased farmer's deferred tax liability. This would be a tremendous burden if the heir continues to farm.
Certain assets do not get a stepped-up basis, including IRA, 401(k), pensions, tax-deferred annuities and money market accounts. Beneficiaries should be aware of the new rules for inherited IRAs and the resulting tax liabilities.
Bringing to light the benefits of stepped-up basis, I would urge you to speak to your congressional representatives and inform them of the tremendous benefit stepped-up basis is to farming.
DTN Tax Columnist Rod Mauszycki, J.D., MBT, is a tax principal with CLA (CliftonLarsonAllen) in Minneapolis, Minnesota. Read Rod's "Ask the Taxman" column at about.dtnpf.com/tax. You may email Rod at firstname.lastname@example.org.
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