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					               Class 43
    Income tax and Estate Planning

•   IRS Site for information:
•   #45 -- Final Exam – Dec. 15 -- 3:20-5:20
•   Clean book buy back? $20?
•   Quiz 15 Critique
•   Papers due on Friday, but, if necessary
    – Better to study for lecture Friday and have
      questions, and hand in the paper by Tuesday
                   Quiz #15
        -- Critique -- any questions--
• 1. Like-kind exchange             4. Capital gain is reported on a:
  treatment is mandatory when a
  farmer trades for a newer              a. Schedule F
  machinery.                             b. Schedule C
                                         c. Schedule D
• 2. Capital gains treatment is
  available for a farmer’s          5. Tax basis of a donee’s gift of a
  breeding animal sales.                 capital asset is in the hands of
                                         the donee:
• 3. Cost recovery (depreciation)
  is a essentially mandatory.            a. Cost to the donor
                                         b. Adjusted basis at the time
                                         of the gift.
                                         c. Market value of the asset on
                                         date of the gift
    Ordinary Income & Capital Gains
          Marginal Tax Rates
                                 -- Marginal   Rates --
•   2005 Tax Brackets      Ord. Inc.
•   Married Filing Jointly STCG                LTCC*
•   Over But not over < 1yr                    >1 yr
•   $0          $14,600     10%                  5%
•   $14,600     $59,400      15%                5%
•   $59,400     $119,950      25%               15%
•   $119,950 $182,800         28%               15%
•   $182,800 $326,450         33%               15%
•   $326,450      ………        35%
•   __________
• *Generally, greater than 1 year is the long term holding period.
  These lower rates apply after May 5, 2003 thru Dec. 31, 2007??
         Schedule D Calculation
                   --Capital Gains--
• Facts:
• 1. $40,000 of taxable income, line 43 of Form1040
• 2. $50,000 of net long term capital gain income (LTCG) MFJ
  is the tax status, and the the lower bracket stops at
  $59,400 (2005) which allows $19,400 of the $50,000 LTCG
  at a 5% cap. gain rate($970), and $30,600 at a 15% cap. gain
The tax on the LTCG = $970 + $4,590 = $5,560
• What is this taxpayer’s total federal income tax liability?
• Ans. Use Schedule D and the tax tables or tax rate schedule.
             Form 4797—Examples
        Disposing of Farm Business Assets
               » Examples                        A         B         C
• Line 20—Gross Sales Price                     $90     $20,000 $50,000

•   Line 21– cost or other basis+Sale Exp. -0-           50,000 30,000
•   Line 22–Depreciation(Allowed/Allowable) -0-          40,000 30,000
•   Line 23– Adjusted Basis (21-22)         -0-           10,000 -0-
•   Line 24 – Total Gain (20-23)             90           10,000 50,000
•   Line 25– Section 1245 Property
     – A --- Depreciation                       -0-       40,000    30,000
     – B --- Enter smaller of line 24 or 25a     -0-      10,000     30,000
     – *********************
     – Results for Example A is $90 of capital gain
     And for Example B all of the $10,000 of gain is recaptured depreciation,
       and that is ordinary income. Example C generates $20,000 of capital
       gain and $30,000 or ordinary income as recaptured depreciation.
         Form 4797 –Summary*
• Line 30 Add A thru D, of Line 24 $60,090
• Line 31 Add A thru D, of Line 25b $40,000
   – (Line 31 is recapture of depreciation and is
     ordinary income.)
• Line 32 (30-31) Enter on Line 6       $20,090
   – It’s Long term capital gain (LTCG)!
   – Taxed at a lower rate!
   – _____________
   – * Separates ordinary income (recaptured
     depreciation) from capital gains.
         Like-Kind Exchanges
             IRC Sec. 1031
• Section 1031(a)(1) provides that:
• --“No gain or loss shall be recognized on the
  exchange of property held for productive use in
  a trade or business or for investment,
• -- if such property is exchanged solely for
  property of like-kind which is to be held either for
  productive use in a trade or business or for an
   – Generally, in a trade or business, non-
      recognition is mandatory.
             Like- kind Exchanges,
                 IRC Sec. 1031

• In simple terms--
• If one trades property for like-kind property
• and, does not receive cash or other non-like-kind
  property (called boot).
• Then no profit has been made, nor income to
             Like-Kind Exchanges
                 IRC Sec. 1031
• Like-kind exchanges under Sec. 1031 allow for
  considerable flexibility
• -- at least in real estate deals.
• “Any type of real property interest is like-kind to
  any other type of real property.
• -- The properties do not have to be of the same
• Starker, (602 F. 2nd 1341 (9th Cir. ‘79 )?), and
  subsequent 1991 Treasury Rules allow for
  timing-flexibility in sales, ‘and replacements.
             Like-Kind Exchanges
                 IRC Sec. 1031
• “Pre -Starker” rules.“The taxpayer had to locate a
  replacement property in advance, and prepare to
  close the sale of the primary property, and the
  replacement property as part of a single, perhaps,
  complicated escrow.”
• “Starker deals” --today.
  – 1. From the day a taxpayer parts with his property, he
    has 45 calendar days (holidays and weekends included)
    to find the replacement property.
          Like-Kind Exchanges
              IRC Sec. 1031

• It is critical that the proceeds in 1. go into
  escrow or a trust account rather than be held by
  the seller looking for an exchange.
• If there are multiple properties, the time limit
  begins to run on the date of the transfer of the
  first one.
         Like- kind Exchanges,
             IRC Sec. 1031

• 2. The replacement property must be transferred
  to the taxpayer by the earlier of 180 days from the
  closing in #1,
• or the due date (including extensions) of the
  taxpayer’s tax return!
• The 180 day time period may not be extended
  even if it ends on a non-business day!
            Like-Kind Exchanges

• 3. A qualified intermediary safe harbor:

• To perfect the exchange under this safe harbor, the
  qualified intermediary must acquire title to both the
  relinquished and replacement property,

• or enter into a contract with the relinquished property
  buyer and the replacement property seller.
          Like-Kind Exchanges,
              IRC Sec. 1031

• An example:
• A farmer gives up “farming on the fringe,”
  knowing he can sell his farm for $500,000.
• Farmer has a much larger parcel lined up “out in
  the county” for $600,000.
               Like-Kind Exchanges
                      An example:
• Farmer sells to the developer or “speculator” for $500,000,
  borrows the $100,000 to acquire the $600,000 farm --
  within the rules of Sec. 1031.
• -- the $500,000 might be in a qualified escrow or trust
  account, until paid-over in the acquisition of the
  replacement property.

• What is the income tax basis of the “new farm?”
          Like-Kind Exchanges
      Basis of Replacement Property
• Basis of the replacement property is the basis of the
  relinquished property plus the extra amount (boot) paid
  to get the replacement property.
• For an “even trade,” the basis of the replacement
  property is the same as it was in the relinquished
   – Whether personal or real estate is the subject of the
• A $20,000 tractor that has a zero basis (fully
  depreciated) traded for a $20,000 planter will leave the
  farmer with a planter that has a zero tax basis.
      Like-Kind Exchanges,
IRC Sec. 1031-Basis of Replacement

 • A parcel of land with a basis of
   $100,000 traded for another parcel
 • -- “even up,” will leave a replacement
   property with a basis of $100,000
 • -- if an extra $100,000 (boot) is required
   to get the replacement parcel, it will
   then have basis of $200,000.
   Sale or Exchange of a Personal
      Residence -- Section 121
• No tax on capital gain up to $500,000 for married
  filing jointly (nor on $250,000 if single or filing
• -- As long as the taxpayer(s) has inhabited the
  residence “two of the prior five years.”
• --- Pro-rata rules for shorter habitation periods.
• Note, an ex-spouse may individually qualify for
  $250,000 exclusions when one ex-spouse
  continues to live in a co-owned residence.
 Sale or Exchange of a Residence -
            - Section 121
• The $500,000 exemption is for a married couples if:
   – Either spouse meets the ownership test
   – both spouses must meet the use test, and
   – neither spouse is ineligible for exclusion by virtue
     of a sale or exchange of a residence within two
• This exemption may be used numerous times.
  There is no limit beyond the “two of five” rule on
  qualifying for this exemption.
          Estate Planning
        Goals and Objectives

• Accumulating an efficient-sized business
• Maximizing the transfer of assets between
• Assist children or other descendants in “getting
• Others? ________________________
     Life Estate— in Dad’s Will
• ... THIRD: I give to my said wife the use, possession and
  income during her lifetime of the farm owned by me in
  Woosung Township in Ogle County, Illinois. I request that
  she pay all general taxes which become a lien against it
  during her lifetime and that she keep the buildings and other
  structures insured against loss by fire, lightning and
  windstorm for their reasonable insurable value and in a
  reasonable state of repair.
• In case any of the buildings are damaged or destroyed by any
  casualty covered by the insurance, the amount recovered
  shall be used to repair or replace them unless otherwise
  agreed between my said wife and the nine remaining owners
  of the farm.
• Subject to the life estate herein given to my said wife, I
  give and devise my said farm in Woosung Township to
  my children, share and share alike. In case of the death of
  any of my said children prior to my death leaving a child
  or children surviving, such child or children shall receive
  the share of my estate the parent would have received if
  living. ...
          Buy-Sell Agreement
            -- an example --
• a. Each party shall have the right to purchase
• in the same proportion as his or her individual
  interest bears to the total interest of the other
  beneficial interest holders at that time, provided
• if one or more of the beneficial interest holders
  shall elect not to purchase his or her proportion
  of the selling party's interest
         Buy-Sell Agreement
           -- an example--
• the unexercised portion of the first right to
  purchase shall be pro-rated among those
  who exercised their right to purchase on
  the basis of their respective pro-rata
An estate planning example: An
Indian -- from New Delhi, India -- had
17 elephants, and wants to divide
them between three sons.
He wants to give:
1/3 to one son,
1/2 to a second son,
1/9 to the third.
His lawyer suggests this: “Take one of my
elephants, now you have 18.”
1/3 of 18 is 6
1/2 of 18 is 9
1/9 of 18 is 2.
That totals 17!
You can return the lawyer’s elephant, and
his fee, and be on your way!
         Property Ownership
•   Sole Ownership
•   Tenancy in common
•   Joint tenancy
•   Tenancy by the Entirety
•   Life Estate
    – Retained Interest
    – Granted Interest
•  Remainder Interest
• See the handout sheet “characteristics of
  types of ownership”-- lifetime and after death.
• See Table 2 in EC -519 showing “probate” Est. Tax
  and Indiana Inheritance Tax.

How will the life tenant handle:
- Insurance coverage
- Management: day-to-day, and long term
   - Maintenance of the property
   - Level of income, rental arrangements?
- Is the “actual tenant” a “stand-in” tenant ?
- Yet, this approach in dividing interests is solid tax
- The better approach may be a trust holding
   the interest.
    Indiana Law of Descent (no will)
                                         • Who Receives What
• Survivors
                                         •   ½ to spouse and ½ to child or
•   Spouse, 1 or more children               children

•   Spouse, and decedent’s parent(s),    •   ¾ to spouse, ¼ to parent(s)
    no children
                                         •   All to spouse
•   Spouse only
                                         •   Spouse: ½ of personal property,
•   2nd or subsequent childless spouse       25% of real estate value; balance
    with children of decedent’s prior        to children
                                         •   All to children
•   Children only (single parent)
                                         •   Parents and sisters and brothers
•   No Spouse or children                    share equally, but parents get at
                                             least 1/4
 Surviving Spouse’s Elective Share

• Election against a deceased spouse’s will
• It is a right separate from the law of descent!
• If first spouse or spouse with children the
  elective share is ½!
• If second or subsequent spouse without children
  by the deceased spouse:
  – For real estate, 25% of the FMV.
  – For personal property,1/3 .
  – Note, children have no “elective” share!
           Estate Administration?
• Taking charge and supervision of a decedent’s
   – By a local court through the services of a duly
     appointed personal representative
   – Generally, with assistance of an attorney!
• Getting title in assets to the right people or entity
   – Pay transfer (estate and inheritance) taxes and
     income (state and federal) taxes and valid claims
   – that is the essence of the process.
• See the Estate Administration flowchart.