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
-- 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
• 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
• 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.
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
• 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.
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
IRC Sec. 1031
• Like-kind exchanges under Sec. 1031 allow for
• -- 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.
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,
• “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.
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
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!
• 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.
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.
• 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
• What is the income tax basis of the “new farm?”
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.
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.
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
-- 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
-- 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!
• 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.
PROBLEMS WITH A LIFE ESTATE
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
Indiana Law of Descent (no will)
• Who Receives What
• 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)
• 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
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!
• 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.