As March ended this year, the Biden Administration issued a 250-page General Explanation of the administration’s fiscal 2023 revenue proposals, sometimes known as the “Green Book”. This is a very brief initial summary of the Green Book provisions which I believe would revolutionize, and have the greatest impact on, estate planning and real estate investing.
Green Books Are an Administration’s Wish List, BUT…
Green Books reflect an administration’s wish list Rarely does an administration get Congress to give it all it wishes to have, but this year’s proposals would, if adopted, have a huge impact on real estate investing.
Top 6 Scariest Provisions for Real Estate Owners to Worry About in Their Planning
- Tax Unrealized Capital Gains upon Death or Gift
- Limit Valuation Discounts
- Tax Sales Between Grantor Trusts and Grantors
- Deny Most 1031 Exchanges
- Increase Depreciation Recapture Taxes
- Limit Exemption from Generation Skipping Taxes
This year, given a divided Congress, and Senators Manchin and Sinema’s reluctance to support tax increases, OUR BEST GUESS is that it is unlikely all, or even many, of the provisions will pass this year.
Still, as you think about your estate planning, you should bear in mind this version of a Democratic wish list as you plan for the longer term. And, if the Dems can get their act together (sooner or later), this may be their last chance in this Administration to get any tax increases or reform passed, and your last chance to do good planning. So, remember my motto: If you fail to plan now, plan to fail.
A Few Words About Effective Dates
It does not appear that the Green Book provisions, as drafted, are scheduled to be retroactive. So, planning completed before they are passed, or before possible deferred effective dates, may escape adverse effects. Usually, but not always, legislation changing the treatment of irrevocable trusts and completed transactions is NOT made retroactive to a date earlier than the date of enactment, or the beginning of the following year, though sometimes, to discourage further planning, an earlier effective date (like the date of the first hearing on legislation re some aspects of reform) is proposed as an effective date.
Tax Unrealized Capital Gains upon Death or Gift – Limited Step-up of Income Tax Basis
The proposals would impose income taxation on death or gift for unrealized capital gains. Fortunately, the proposals do provide a $5,000,000 (as adjusted for inflation) exclusion from the imposition of capital gains taxes on transfers during lifetime or at death, and transfers to charity or a spouse would not be subject to these rules.
Limit Valuation Discounts
Valuation discounts for fractional interests would be disallowed unless the transfer is of an interest in an active trade or business, in which case valuation discounts would still apply to the extent assets are actively used in the conduct of such active trade or business.
Currently, transactions can usually be structured so valuation discounts will allow you to “leverage” your estate and gift tax exemptions. These discounts are very important if your undiscounted net worth exceeds your estate and gift tax exemptions.
Tax Sales Between Grantor Trusts and Grantors
Currently, such sales are not subject to income tax. Such sales are very important to planning under current law. Clients with substantial estate tax exposure should therefore consider getting such sales done before a provision like this is adopted. Generally, this strategy works better if adopted when you have more life expectancy than waiting until you have less life expectancy remaining.
Deny Most 1031 Exchanges
Many property owners use 1031 exchanges to defer income tax on the “sale” of highly appreciated property. The proposal would allow deferral of only $500,000 per taxpayer each year for 1031 like-kind exchanges of real property. So, “swap ‘til you drop” may no longer work. Owners considering exchanges may therefore want to complete them before this provision becomes effective.
Increase Depreciation Recapture Taxes
The proposal would apply ordinary income taxes (instead of capital gains taxes) to be paid to the extent of prior straight line depreciation deductions on the sale of depreciable real property. In the past, only prior accelerated depreciation deductions were subject to this recapture.
Limit Exemption from Generation Skipping Taxes
The Generation Skipping Tax rules allow wealth to transfer under trusts from children to grandchildren and younger generations through trusts without a Generation Skipping Tax (like a new estate tax) at each level. The proposals limit the duration of the exemption allocated to trusts only as long as the life of any trust beneficiary who is a current beneficiary and either is no younger than the transferor’s youngest grandchild or is a member of a younger generation but who was alive at the creation of the trust regardless of the term of the trust.
This will reduce the long term effect to state laws that eliminated or greatly extended the Rule Against Perpetuities to allow trusts to continue for multiple generations.
GRAT Changes
The proposals regarding Grantor Retained Income Trusts (“GRATS”), which are often used to provide for appreciating assets to be removed from an affluent person’s estate, require that any remainder interest in a GRAT must have a minimum value, at the time the interest is created, equal to the greater of (1) 25% of the value of the GRAT assets or (2) $500,000 (provided that the total value of GRAT assets is greater than $500,000). These proposals would (a) prohibit the Grantor from re-acquiring via exchange an asset held in the GRAT without recognizing gain or loss, (b) require that GRATs have a minimum term of 10 years and a maximum term of the life expectancy of the annuitant, plus ten years, and (c) provide that payment of income tax on assets held by the GRAT is considered a gift.
Gift Tax on Payment of Income Tax on Defective Grantor Trusts
Grantors would also be subject to gift tax on the payment of income tax attributable to what is known as a “Defective Grantor Trust”. This may apply for trusts already established, and may cause many families to swap assets with existing trusts before this law comes into effect in 2023.
Consistent Treatment of Promissory Notes
In another attack on the use of Grantor Trusts, the proposals require consistent treatment in the valuation of promissory notes. This would preclude use of a strategy where property is sold to a grantor trust in exchange for a long term note with a face value equal to the value of the assets sold and an interest rate at the (usually low) Applicable Federal Rate. Even though the low rate is an economic gift to the beneficiary, no gift is deemed to have been made for tax purposes. However, if you later die while the note is outstanding, some planners think that the long term note issued at the Applicable Federal Rate can be valued at a discount if subsequently transferred when a market rate note would be at a higher rate. The proposals would eliminate this dichotomy by requiring the note to be valued as if it was a demand note with no discount for a “below market” interest rate.
New Informational Reporting
The proposals would require new annual informational reporting on the total value of assets held in domestic trusts, similar to current reporting required for assets held in offshore trusts, if the value of the trust’s assets exceeds $300,000, or if the trust’s income for the tax year exceeds $10,000. This should not increase taxes, but adds to the reporting burden.
Wealth Tax
Taxpayers having a family net worth of over $100 million may face a “constructive sale tax” that would treat them as having sold their capital gains assets subject to a 20% capital gains tax, which would be payable. This new tax would be payable over a period of nine years. For example, a family having a net worth of $100 million that consists of $50 million in assets that are worth what they cost and $50 million of assets that cost $20 million would have a capital gains tax imposed on $30 million, and would thus owe approximately $6 million in taxes without having sold any.
Potential Good News – No Reduction in Estate Tax Exclusion YET
The proposals do not mention reducing the $12,060,000 per taxpayer estate and gift tax exemption, which is going up with inflation and is scheduled to go up with inflation, but that may be because the exemption is scheduled to be cut in half January 1, 2026 unless the law is changed before then. OUR BEST GUESS is that the higher exemption is unlikely to be extended and, if it is extended, expect it to later be reduced.
NOTE: Bernie Sanders has proposed that the exemption come down to $3,500,000 and not increase with inflation thereafter.
But, if my parents or grandparents were likely to have an estate over $5-6 million each when they pass away (lower, if you worry about Bernie), I would urge them to consider planning to reduce their taxable estate NOW.
Kenneth Ziskin, an estate planning attorney, focuses on integrated estate planning for apartment owners to save income, property, gift and estate taxes. He also provides trust and probate administration assistance after the death of a loved one. He holds the coveted AV Preeminent peer reviewed rating for Ethical Standards and Legal Ability from Martindale-Hubbell, a perfect 10 out of 10 rating from legal website AVVO.Com, and is multiple winner of AVVO’s Client Choice Award. Ali Talai and Ken frequently work together on client projects. Ken and Ali offer FREE consultations for AOA members in appropriate cases. Call Ken at (818) 988-0949 and Ali at 818-992-2901. See Ken’s website at www.ZiskinLaw.com and Ali’s website at www.TalaiLaw.com. This article is general in nature and not intended as advice for clients. This article may be considered attorney advertising. Please get advice from counsel you retain for your own planning. Drafted in late April, 2022.