Tax Liability

It’s absolutely critical you thoroughly think through the tax implications of an estate plan in California before you construct one. This is an especially complex area, with the loved ones you leave behind facing somewhat severe consequences with any misstep you may make. Yet, at the same time, being successful brings with it a considerable upside, and they’ll be grateful to you for having taken care of it all for them.

Reducing And Avoiding Taxes

Many people, for whatever reason, have this idea in their mind that the government — both federal and state — is drooling at the mouth, waiting to pounce on all of your money via something like a death tax or probate. This isn’t the case. Federal estate taxes only apply to estates that are valued at $13.61 million dollars. Most people’s estate is not valued this high, but it can have significant implications for those whose assets approach or exceed this threshold, necessitating careful estate planning to mitigate potential tax liabilities and ensure the smooth transfer of wealth to heirs.

Estate planning affords those who seek it the ability to mitigate taxes. Although it can’t serve as a way to lower or eliminate income tax, you can mitigate issues associated with capital gains tax, estate tax, and property tax.

Laws that regulate these matters change all the time, so if you aren’t intentionally dedicating your time and effort to follow them, you may miss out on valuable opportunities to optimize your tax strategy. Additionally, without proper guidance, you could unknowingly make mistakes that cost you while significantly complicating the estate settlement process for your heirs.

Property Taxes

Setting up your estate plan to reduce or avoid estate taxes is certainly possible, but there are a number of factors at play. We’ve found over the course of our time handling estate planning that people are most commonly concerned with two issues. The first is, If I pass my home onto my family, will they keep the same property tax basis and rate I had?

Proposition 19, more commonly called Prop 19, which went into effect in 2021, has a lot to do with these determinations. It did a lot to significantly reduce the property tax loophole. Prior to taking effect, someone who owned property could pass all of their real property onto their children or grandchildren, who would keep the same property tax rate. For someone who bought a home years ago and is subject to a very low property tax rate, this can make a huge difference in whether a beneficiary can even keep or maintain the home.

Let’s flesh this out with an example. Say someone bought a legacy beachfront property in the sixties for two hundred thousand dollars, and they’re essentially paying property taxes based on that rate today (plus reasonable growth). Let’s also say the property is now worth three million dollars. If their beneficiary does not keep the same tax basis, that is, if they fall outside of Prop 19, they may be on the hook for tens upon tens of thousands of dollars in property tax every year. Pending their specific financial situation, this may not be feasible, causing them to sell the property. This can be utterly devastating.

Under Prop 19, exemptions have been reduced such that individuals can only transfer their primary residence to a child or grandchild. Additionally, the child or grandchild has to receive and take that property as their primary residence. Contrasting this against how things were arranged prior, where property owners could pass on any of their potentially multiple properties to any child or grandchild, a lot has changed, creating a lot of headaches for many of our clients. With some leg work and drive, we have been able to get around this in some cases, though, and a good estate planning attorney could likely do the same for you if necessary.

Changing Cost Basis

The second common issue our clients are concerned with is, What happens if my children sell my property? Are they going to get hit with estate, property, or capital gains taxes? Unfortunately, the answer is not as straightforward as you may want it to be.

When discussing this, we always use an example: Let’s say you own a home that you bought for a hundred thousand dollars — your cost basis or purchase price — and it appreciates to a million dollars. If you sold it for a million dollars, you would be subject to capital gains taxes on the difference between your purchase price and the sale price, excluding any applicable exemptions you may have.

Let’s entertain a different hypothetical situation and say you didn’t sell the property during your lifetime. Instead, you had undertaken some strategic estate planning, and the property was owned by your trust, which became irrevocable. In this situation, the purchase price would step up to the date of death value. To put it more plainly, the cost basis wouldn’t be one hundred thousand — it steps up to a million dollars. Thus, if your heirs were to sell it at that price, they wouldn’t be subject to any capital gains taxes.

While we strive to provide comprehensive guidance to our clients, we aren’t a replacement for a financial advisor or a Certified Public Accountant (CPA) when it comes to financial matters and tax implications. We can offer general advice based on our experience, but we can’t offer specialized advice for personalized financial planning, especially regarding selling property.

Given the complexity and potential changes in tax laws, we highly advise working closely with a knowledgeable tax professional in collaboration with an estate planning attorney to find the best possible outcome for your unique situation.

For more information on Tax Implications Of An Estate Plan In California, an initial consultation is your next best step. Get the information and legal answers you are seeking by calling (951) 262-8811 today.