Implications of Giving Your Tree Farm to Family Members
Tree Farmer Magazine: March/April 2007 - Volume 26 No. 2
The most common estate planning question I receive involves the implications of giving your Tree Farm to your children or other family members instead of waiting until your death for the transfer. There's something very tangible and emotional about sitting in the attorney's office with your children to sign the transfer documents. For many Tree Farmers it's a joy to watch as the children take charge of the management of the property, allowing mother and father to sit back and enjoy walking the woods with the grandchildren without having to deal with the responsibilities of ownership. There are many benefits, but also tax implications. As always, these implications are in large part a function of the value of the Tree Farm. Also, the needs of many Tree Farmers and their heirs make it necessary to have multiple owners and, therefore, more contractual complications. Let's consider the potential estate, gift and income tax implications.
As you've become aware by now, estate planning is extremely complicated under any circumstances, but it's even more so now because changes over the next few years and the return to the law prior to the 2001 tax act unless Congress takes action before the phase-out on december 31, 2010. Recall that 2010 is the year without an estate tax, but with the gift tax.
I continue to recommend that estate plans be based on the assumption that the excludable amount is $1 million. This means that if your taxable estate exceeds this amount, your executor will need to write a check to the IRS. So, one reason to give away the Tree Farm before you die is to lower the value of your estate. The Tree Farm will not be included in your estate if the transfer to your children constitutes a completed gift. Your attorney can explain what this means, but essentially, if the documents transferring ownership specify that you retain any ownership interest, the value of your interest will be included in your estate.
Retaining a partial ownership interest may be desirable if you want to share in the income from the Tree Farm. Your partial interest could be in the form of a tenant in common, a shareholder in a corporation, a partner in a partnership, or a member of a limited liability company. Management control is also an incident of ownership. Thus, if you retain the right to make major management decisions, your gift may not be complete. If you retain a partial ownership interest in a Tree Farm of significant value, your executor will be faced with the problem of determining the fair market value of a partial interest. Also remember the importance of using the excludable amount of both you and your spouse.
Gifts you make to an individual may be subject to the gift tax. There is an unlimited exclusion of transfers to your spouse and for educational and medical support. Gifts to qualified charities are also excluded. There is also the annual exclusion of $12,000 per recipient. Thus, you can give up to $12,000 per year to any number of recipients. If you and your spouse both want to make a gift to the same recipient and use both of your annual exclusion amounts, you'll need to file a gift tax return to report a split gift. This is the case whether you give assets that are owned individually or jointly. In addition to the excludable amount for estate tax purposes, there is a lifetime excludable amount of $1 million per person. Example 1 demonstrates how this works. Note that the gift tax rate for taxable gifts after 2009 will be 18 percent for the first $10,000 and max out at 35 percent for gifts over $500,000. This will be lower than the maximum estate tax rate.
Example 1: Mark Majors made taxable gifts totaling $850,000 by the end of 2005. He filed gift tax returns for any year that he made taxable gifts, even though he did not owe any tax. In 2006 he made additional taxable gifts totaling $200,000. this made his total lifetime taxable gifts $1,050,000, using up his $1 million lifetime exemption. Thus, when he filed his IRS Form 709, U.S. Gift Tax Return, for 2006 he owed tax on $50,000. the tax due was $10,600. He would have to pay the gift tax on any future taxable gifts.
The major consideration in giving highly appreciated property is that you are also giving the income tax liability on the appreciation in value. If the recipient sells the property in whole or in part, for example by selling timber. they would owe tax on the amount they received less your basis in the property at the time you made the gift. This is because the basis of gifts in the hands of recipient is the basis of the giver on the date of the gift, a carryover basis. The recipient's basis would be increased by the portion of any gift tax you paid resulting from the appreciation in value while you owned it. If your children are in a lower income tax bracket than you are, having them pay the income tax may be advantageous.
The estate plans of most Tree Farmers generally involves a husband and wife, in other words, two coordinated estate plans. Thus, transfers to the surviving spouse, as well as to the next generation, must be considered. Recall that when one spouse dies 50 percent of any jointly held property is included in the estate of the first spouse to die. Thus, if the Tree Farm goes to the surviving spouse, he or she gets a 50 percent step-up in basis, as demonstrated in Example 2.
Example 2: Joe and Joanne Jones hold joint title to the Piney Woods Tree Farm. When Joe died, their adjusted bases in the land and the timber were $120,000 and $200,000, respectively. The date-of-death fair market values were $240,000 and $720,000, respectively, for the land and timber. Joanne's basis in the land becomes $180,000, composed of her half of the adjusted basis, or $60,000, plus half of the fair market value, or $120,000. Her basis in the timber is $460,000, her half of the adjusted basis, or $100,000, plus half of the fair market value, or $360,000.
If Joe was the sole owner of Piney Woods, Joanne's basis after his death would be the fair market values. I know what you're thinking. If a couple holds joint title why not re-title to the first spouse expected to die so that the surviving spouse gets a full step-up. This can be done using the unlimited gift tax marital deduction, but if the transfer is not made more than one year prior to death, the 50 percent step-up will apply, not the 100 percent. This procedure is not commonly used because of the benefits of joint ownership.
Legal Advice Essential
Given the complexity of the tax and property laws, you should not take any action without legal advice. And yes, you may need to shop for an attorney to find one with the needed background and with whom you can develop a trusting relationship.