In my August 15 blog, I noted that proposed regulations issued by the Treasury Department and IRS would significantly limit the ability to use valuation discounts in the context of transferring interests in family-owned entities to family members. These regulations would have a particularly significant impact in the case of real estate business owners.
All business owners have an opportunity to take advantage of discounts now by gifting family entity interests before the rules become final. However, when you have a real estate entity, there are some special considerations. With real estate, the income tax basis of the assets could be significantly lower than the market value because in real estate you can depreciate the assets as well as refinance mortgages and distribute additional dollars out to the owners.
If an individual has a family owned real estate entity worth $100 million and a tax basis of $10 million, he or she will not necessarily want to give the property away and risk losing the benefit of a step-up in tax basis at death. In the example, the income tax basis of the interest would be increased to its fair market value of $100 million at the time of death. By using the step-up, the beneficiary is only responsible for the capital gains tax on the appreciation in value that occurs from the date of death to the point when they sell, which provides a huge income tax advantage that may dwarf the estate tax savings of the discounts. Even if the beneficiary has no plans to sell, he or she can still take advantage of the significant income tax benefit of depreciation based on the stepped-up value of the asset.
If you have questions about how these proposed regulations could impact you, contact me at SDitman@berdonllp.com or your Berdon advisor.
Scott T. Ditman, a tax partner and Chair, Personal Wealth Services at Berdon LLP, New York Accountants, advises high net worth individuals and family/owner-managed business clients on building, preserving, and transferring wealth, estate and income tax issues, and succession and financial planning.