It’s no secret that the value of real estate in Southern California is through the roof. This trend has been ongoing for some time, and in April, prices went up by over 20 percent year-over-year according to the L.A. Times.
Watching the numbers go up is satisfying, but from an estate planning perspective, there is an inherent threat that goes along with the accumulation of wealth.
Federal Estate and Gift Tax
Inheritances are not subject to regular income taxes because it would be double taxation. If you inherit money, the person that left you the bequest paid taxes while they were alive, and their estate is an after-tax accumulation.
This logic is completely thrown out the window if the amount that you are receiving exceeds a certain amount. We have a federal estate tax in the United States that is separate from the income tax, and it is potentially applicable on the portion of your estate that exceeds the exclusion.
A piece of legislation was enacted in 2011 that set the exclusion at $5 million, and it remained in place indexed for inflation through 2017. The Tax Cuts and Jobs Act was enacted at the end of that year, and a provision contained within it dramatically increased the exclusion.
It went up to $11.18 million in 2018, and it currently sits at $11.7 million. The maximum rate of the estate tax is 40 percent at the present time.
There are provisions in place for married couples, and one of them is the marital deduction. As long as you are married to an American citizen, you can leave them any amount of property and the estate tax would not be a factor.
Of course, they would be in possession of an estate that could be taxed, but the estate tax exclusion is portable. A surviving spouse would have two exclusions to combine, because they could use their deceased spouse’s exclusion.
There has been a gift tax in place since 1932 to prevent people from giving lifetime gifts to get around the estate tax. These taxes are unified, so the exclusion applies to gifts that you give while you are living and your estate.
On the good news side of the coin, there is an additional gift tax exclusion. Each taxpayer can give a maximum of $15,000 to an unlimited number of people each year tax-free without using any of their multimillion dollar gift and estate tax exclusion.
Obviously, your real property is part of your estate. Dramatic property value increases are fantastic on the one hand, but you should monitor your potential estate tax exposure.
Tax Act Sunset and For the 99.5 Percent Act
The provision in the Tax Cuts and Jobs Act that established the record high exclusion is going to sunset at the end of 2025. On January 1, 2026, the exclusion will revert to the $5.49 million level that we had in 2017.
This is concerning enough, but there is another threat in the form of the For the 99.5 Percent Act. It has been introduced by Senator Bernie Sanders of Vermont, and it would reduce the estate tax exclusion to $3.5 million.
Under the terms of this measure, the rate would go up to 45 percent for estates that do not exceed $10 million in value, it would reach 50 percent for larger estates. It would continually rise until it tops out at 65 percent for estates that are worth more than $1 billion.
Clearly, the potential for estate tax exposure is likely to increase over the coming years, so you should pay close attention to the subject as time goes on.
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