The entirety of an individual’s personal property and real property that they own at the time of their death is known as an estate. An estate plan includes legal documents and tools used to fulfill an individual’s wishes for their property once they pass away. It may include different documents depending on the individual’s circumstances. An estate plan can include:
- An individual’s will;
- A trust or trusts; or
- Different powers of attorney.
A will is a legal document, usually written by an attorney but created by an individual, called a testator, that specifies how their property will be distributed at death. The will can include personal property or real property.
A trust is a legal instrument created by an individual to hold their property for the benefit of an individual known as the beneficiary. The person responsible for managing the trust is known as the trustee. Trusts may be created for many reasons and have different requirements set by the testator. For example, a money trust may be created for the testator’s grandchild which holds the money until the child either reaches the age or majority or graduates college.
A power of attorney is a legal document that gives one individual the power to make decisions on behalf of another individual should they become unable to do so. There are many different types of powers of attorney that can be used for different aspects of an individual’s life.
For example, a financial power of attorney gives one individual the right to handle another individual’s financials, including actions such as paying bills and buying or selling property.
deceased. In some cases, it is also possible for individuals to apply to become the executor of an estate.
What are the Estate Taxes?
Estate taxes are taxes that are owed and must be paid by an individual’s estate after they pass away. Estate taxes are imposed on an individual’s estate by the federal government. They are known by other terms, such as death taxes or inheritance taxes.
If property or assets are transferred to an individual other than the owner upon the death of the owner, an estate tax can be imposed. Most estates will not owe these taxes, federal or state, because of their size. Generally, estate taxes are imposed only when an estate is worth greater than $11.58 million. The tax rate can be up to 40%, depending on the size of the estate.
What are State Estate Taxes?
Some states impose a state estate tax, also called an inheritance tax, in addition to the federal estate taxes. The following states collect estate taxes as of 2019:
- Iowa;
- Kentucky;
- Maryland;
- Nebraska;
- New Jersey; and
- Pennsylvania.
Each state has different laws and exemptions from the inheritance taxes. Certain individuals or certain estate may not be required to pay an estate tax, even in the states listed above.
What is a Gross Estate?
A gross estate is the total value of an individual’s personal property, real property, or any other assets they own when they pass away. This can include cash, investments, or personal belongings. The net value of an individual’s gross estate is the value of the gross estate minus certain eligible deductions, including:
- Expenses;
- Debts;
- Claims; or
- Other losses that may be deducted.
What Taxes do I have to Pay on a Remainder Interest?
Pursuant to current tax laws, the value of any real property owned by the taxpayer is included in the calculation of the taxpayer’s gross estate. This applies even if the property will transfer ownership upon the owner’s death. Selling a remainder interest in a property can be a way to avoid including the value of the property in an individual’s gross estate.
A remainder interest is a future interest in land. It includes the right to own and possess land after the interest of the current owner expires.
Will Selling this Interest Reduce my Estate Tax?
Since the estate tax is imposed on an individual’s gross estate, one way to reduce that tax is to reduce the gross estate as much as possible. If an individual sells their reminder interest for “full and adequate consideration,” they do not need to include the value of the property in the gross estate upon their death. Full and adequate consideration is usually defined as the fair market value of the remainder interest.
For example, individual A decides to sell their remainder interest in his home worth $200,000 for $55,000, the fair market value of that remainder interest. A retains the right to possession of the home until he passes away. If A dies 5 years later and the house is worth $550,000, A’s gross estate will not include the value of the home at the time of the remainder interest sale or the subsequent appreciation.
Do I have to Pay Taxes on the Sale?
Yes, taxes must be paid on the sale. Similar to the sale of any property interest, an individual must pay income tax on the sale of the remainder interest. If an individual makes a profit from the sale, in other words, the sales price exceeds the investment in the property, they will likely have to pay taxes on those gains. If the property is considered a capital asset, the profit will be taxes at the preferential capital gains tax rate.
One way to avoid paying taxes on the entire profit is to sell the remainder interest in an installment sale. It is important to note that installment sales often include interest payments, which may increase the total amount of income on which the seller must pay taxes.
What is a Capital Asset?
Capital assets are all of an individual’s assets, with some exceptions. The most common capital assets include:
- A personal residence;
- A personal automobile;
- Personal jewelry; and
- Stocks and bonds held as an investment by the individual.
Things that are considered exceptions to capital assets are:
- Inventory property of the taxpayer, including stock in trade;
- Any property that is primarily held for sale to customers in the ordinary course of business;
- Depreciable property or real property used in a business or trade;
- A copyright, such as a musical, a book, or an artistic composition, or a copyright such as a letter or memorandum, or similar property, held:
- by the individual who created it; or
- for a letter or memorandum, by an individual for whom the property was prepared or produced; or
- by an individual whose basis in the property is determined by reference to the basis of those who created it or for whom the property was prepared;
- Any accounts or notes receivables acquired in the ordinary course of business for services provided or for sale of stock in trade, inventory, or property normally held for sale to customers;
- Any United States government publications that are acquired by the taxpayer, or received from someone else, who bought the property at a price that is lower than the price which the publications are sold to the public;
- A commodities derivative financial instrument that is held by a commodities derivatives dealer;
- Hedging transactions that are clearly identified as such; or
- Supplies regularly consumed or used by the taxpayer during the ordinary course of business.
Do I Need an Estate Attorney?
Yes, it is important to have the assistance of an estate attorney for any estate planning needs, especially determining how to reduce your gross estate or estate taxes. An attorney can review your estate plan or create one if needed. The attorney can advise you on the best way to distribute your property upon your death, including how your estate will be affected by taxes and how to pass as much as possible to your loved ones.
