Dear Mr. Premack: Years ago my husband inherited ranch land from his parents, when it had very little monetary value. My husband died this year and left the land to me. I have no desire to keep the land. My two daughters also have no interest in the land. I listed it for sale and are about to receive $1.5 million in the sale. I have three questions. Will I lose a portion of the money to taxes? If I give some of the money to my daughters, will they have to pay taxes? How do I keep my sons-in-laws from controlling money that I give to my daughters? Thank you. – B.R.
Let’s start with the history of the ranch. Your husband inherited it, which means it was his separate property. Whatever value the land had on the date he inherited it (plus improvements he may have made to the land) was his “tax basis”. If he was still living and had sold the land like you have, he would owe capital gain taxes on the difference between his basis and the sales price. If his basis was $200,000 and it sold for $1.5 million, his gain was $1.3 million. That is subject to long-term capital gain rates, so he would have owed about $195,000 in taxes.
But he did not sell the land. He willed the land to you upon his death. (I presume you probated his will, became executrix, and in accordance with his instructions have filed a deed that puts full title to the land in your name. If you have not done so, the title company will raise a large objection which will delay the sale until you cure the title by probating his will.) When you inherited the land, you received a “free step-up in basis”.
That means that whatever the land was worth on the date of his death became its tax basis. Since he died very recently and you listed the land for sale, the “fair market value” of the ranch matches its basis. That is, your basis is $1.5 million and the sale price is $1.5 million, so you have no gain and owe no capital gain tax. You just saved $195,000, and that is the answer to your first question.
If you give some of the money to your daughters, do they owe income taxes and gift taxes? Since receipt of a gift is not taxable income, recipients owe no income tax. And since the recipient of a gift does not pay gift tax, recipients owe no gift tax. That is the answer to your second question, but we must take it a step farther. The giver of a gift – you – may have to pay a gift tax, unless the gift is exempt. There are two exemptions: 1) the annual $13,000 exemption, and 2) a $5 million lifetime exemption.
If you give them $750,000 each, the gifts clearly exceed your annual exemption. You must thus report the gifts to the IRS. On the gift tax return, you can apply your lifetime exemption to eliminate tax on the gifts. But be warned: the $5 million exemption is only valid for gifts made in 2012. You should complete this transaction in calendar year 2012 in order to avoid paying gift taxes. If you wait until 2013, the gift tax exemption is scheduled to shrink to just $1 million – so you would owe gift tax on $500,000 of the transfer, and it could cost you about $250,000. Act fast, in 2012, to 1) probate your husband’s will, 2) sell the land, and 3) complete the gifting, and you can save $250,000.
Finally, how do you make the gifts in a manner that will keep the money away from your sons-in-law. Use an irrevocable trust which you establish for the benefit of your daughters. Specify when and how much money can be paid to your daughters. Hire a bank to act as trustee to see that your instructions are followed. Your sons-in-law will then be unable to finagle the money out of their wives’ hands. See a certified elder law / estate planning attorney about your planning options, and talk to your CPA to file the proper tax returns.
Paul Premack is a Certified Elder Law Attorney and a Five Star Wealth Manager (Texas Monthly Magazine 2009-2012) practicing estate planning and probate law in San Antonio.
Original Publication: San Antonio Express News, November 2, 2012