What Is It About …Posted: September 15, 2011
Grandmothers? As you age, many morph from being Grandma to being your friend–unless you and her just don’t see eye-to-eye.
My maternal grandmother, Erna Sahs, died several years ago. Her funeral visitation was on Halloween Night. As I talked with my uncle Stan, I could see the open casket over his right shoulder. Distracted during our conversation, I envisioned Erna sitting up in the casket and announcing “Hey Everybody, I’m baaaaacccckkkk.” Creepy. Clearly, my imagination periodically goes into overdrive.
When I remember Grandma Sahs, I think of farms and the Internal Revenue Service. Yup, I’m a dork.
The IRS says that when you sell agricultural real property (ARP), timing matters. I’m in the mood to talk taxes. (Or as Alan Iverson would say, “We’re talkin’ ’bout taxes.”)
If you sell ARP while alive, capital gain taxes may result. If you pay X for something and later sell it for X+, the IRS considers the difference between X+ and X profit–and the IRS taxes profits to pay for streets and sewers and aircraft carriers and other stuff.
Say you bought some ARP in 1976 for $100,000 and sold the ARP in 2004 for $400,000. You financed the deal with Buyer, who pays you small installments for 3 years and a lump-sum final payment in Year 4. The IRS says you owe capital gain taxes on the $300,000 gain (the difference between the 400k [the sale price] and the 100k [your “basis”]). Your installment sale gain percentage is 75%, right (300k divided by 400k)? So when you get the small installment payments each year (say 10k), you multiply that payment by 75% ($7,500)–then multiply that 7.5k by the applicable capital gain tax rate (probably 15%). You rinse and repeat when Year 4’s lump-sum payment arrives. Man, my head’s starting to spin. Settin’ off my epilepsy …
In summary, the IRS wants some money from you because you made dough on the sale.
Now, how could you have avoided those capital gain taxes (avoided, not evaded)? You could have sold the farm from your grave. The IRS says that if your estate sells your ARP after your death according to your Last Will And Testament, your estate gets a “stepped-up basis”.
Remember that your basis 3 paragraphs ago was 100k. A stepped-up basis, as the term implies, means the ARP’s fair market value at the date of your death can be the new basis. So now what’s your tax?
Yup, that’s right. Your tax is zippo.
The sale price is 400k. The stepped-up basis is 400k (assuming that was FMV). 400k minus 400k is zero. Zero times 15% (or any percent) is zero. Nice work by you ….
So why would anyone sell ARP during his or her lifetime? Probably to know that the deal was done. By you. Not by your estate.
But who the heck cares? Aren’t Wills watertight?
Nope. If your Last Will And Testament says “Sell my ARP to Fred Smith for X amount”, your kids might contest the Will, arguing that “X Amount” isn’t enough and that Fred Smith coerced you. (Remember “Bank On It”‘s discussion about coercion?)
If my writing is all over the board, sorry. If these exercises are useful, great. I need to go to lunch. I’ll let you know how that goes.