Hello BiggerPockets community,
I have been a member here for a couple of months and haven't introduced myself yet. I am new to real estate investing and have bee listening to a few podcasts for a couple months and I want to focus on multi-family investing. My question comes from a co-worker and I thought that you all may be the best place to find answers or direction. His in laws inherited a large ranch in northern California, it is an active ranch with multiple streams of revenue coming from the ranch. They recently received a letter from the IRS stating that they will need to pay an inheritance tax due to the size of the inheritance. (+$5 million) The question is, what can they do in order to not pay the taxes? I was told that they would have to pay close to 50%. Can they sell this ranch and 1031 into something else? Or is there another course of action they can take to help lessen the blow?
@Jason Langmo , a 1031 exchange can be used to mitigate future gain. But this tax is coming from gain exceeding the inheritance tax limits. So a 1031 won't help. Once the tax has been resolved and the new basis established then they can sell and do a 1031 to avoid gain over the new established basis.
Hi Jason, welcome to BP! Unfortunately, the inheritance tax is levied on the value of the decedent's estate at the time of death. So if the decedent held the ranch at the moment of death, it is included in his/her estate, and will be subject to the estate tax. The statutory rate for estate tax in 2017 was 40%. This is a tax that is levied on wealth, not a transfer, and not on earnings, but on the net wealth a person held at death. So if the decedent had other assets besides the ranch, all the assets get added up together for a total value of the decedent's estate, which is then subject to estate tax. In 2017, a decedent could either die with or gift during life a combined $5.49 million dollars before being subject to transfer taxes. Without knowing the full facts here, I cannot say how much tax your co-workers' in-laws will owe, but basically it would be a calculation to the effect of this: add up the decedent's full value of assets owned at death, add up any prior gifts made during the decedent's lifetime that exceeded the annual exclusion, and subtract out $5.49 million. The remaining value will be subject to 40% taxes.
Now there are ways to reduce estate tax with proper planning before death. After death, you are limited to the deductions that you can take on an estate tax return, which the in-laws may want to look into depending on how close they are to being under the $5.49m limitation. Things like funeral costs, final medical expenses, attorneys and accountants fees, debts of the decedent, etc. can sometimes be deducted on the estate tax return. Sometimes these deductions can be taken on either the final 1040 or the 1041 OR the estate tax return so the in-laws will want to work with a good CPA or attorney to plan accordingly.
You also may want to talk with an attorney in order to see if the ranch can possibly be excluded from the decedent's estate depending on how title was held. Perhaps it was held in joint tenancy or in an IRA or some other form which allows the asset to pass outside the decedent's estate. But, if the decedent held it outright at death, there is no escaping the tax through sale or 1031 or some alternate path if the estate is in fact subject to tax.
I am not sure also as to the date of death of the decedent but the in-laws will want to look closely at due dates for the estate tax return, filing for an extension, and having enough liquid funds on hand to pay the tax. There are penalties for not paying in enough tax timely, and interest begins accruing from the date the tax return was due without regard to extensions.
*None of the above information is intended to be professional advice to be relied upon by the reader. It is not intended to create an attorney-client relationship or CPA-client relationship. Please consult with your attorney or tax advisor.
Thank you @Dave Foster and @Katie Lepore . The info was very helpful.
Just to simplify how the inheritance tax works: they would owe 40% on whatever is above $5 mil, not on the whole amount. I.e. if the estate is valued at $6 mil, they will pay 40% of $1 mil, not 40% of the $6 mil. (I crudely rounded my numbers for this illustration)
The details are very well explained by @Katie Lepore
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