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Pennsylvania Preserved Farms Resource Center’s Farm Transition Planning Workshop
November 10, 2016
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Taxable Income Tax Rate Capital Gain Tax Rate
<$18,550 10% 0%
$18,550 – 73,500 15% 0%
$73,500 – 151,900 25% 15%
$151,900 – 231,450 28% 15%
$231,450 – 413,350 33% 15%
$413,350 – 466,950 35% 15%
>$66,950 39.6% 20%
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Taxable Income Tax Rate Capital Gain Tax Rate
<$9,275 10% 0%
$9,275 – 37,650 15% 0%
$37,650 – 91,150 25% 15%
$91,150 – 190,150 28% 15%
$190,150 – 413,350 33% 15%
$413,350 – 415,050 35% 15%
>415,050 39.6% 20%
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Farm/business income
Wages
Interest
Rent
Gain from sale of equipment
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How You Got It How Tax Basis is Determined
Inherited Date of Death Value
Purchase Purchase Price
Gifted Donor’s tax basis transfers
1031 Exchange Tax basis of property sold transfers
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How You Got It How Tax Basis is Determined
Inherited Date of Death Value
Purchase Purchase Price
Gifted Donor’s tax basis transfers
1031 Exchange Tax basis of property sold transfers
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Increases Decreases
Improvements Depreciation for equipment and buildings (not for land)
Partial Sale, such as ag easement or sale of lot
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A surviving spouse can claim 100% step-up in basison jointly titled property acquired from a deceased spouse if:
◦ the property had been acquired jointly before 1977 and
◦ the deceased spouse contributed 100% of the purchase of the real estate property
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Pay 100% in year of sale
Pay over time in installments
Defer through a 1031 exchange
Avoid by giving to charity
Avoid by holding until death
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Seller Financing
With each payment, Seller receives:◦ Interest -Ordinary income
◦ Tax basis -Not taxed
◦ Gain -Capital gain
Gross Profit Ratio◦ Gain divided by Sales Price
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Relinquished Property = Property sold◦ Conservation Easement
◦ Farm
Replacement Property = Property bought
Boot = What you receive when you sell that has not been reinvested in real estate◦ Cash Boot: Cash received
◦ Debt Boot: Reduction in debt
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Relinquished and Replacement Properties must be:◦ Held for business or investment purposes
and◦ Like-kind property
Held for business or investment purposes◦ Not principal residence◦ Not vacation home
Like-kind Property◦ Raw land◦ Rental property
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Identification Period = 45 days after sale of Relinquished Property
Replacement Period = 180 days after sale of Relinquished Property or deadline for filing tax return, if earlier
May need to extend income tax return in some cases
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Cannot use exchange proceeds to build on your own property
Can build on new Replacement Property but must do so by end of the Replacement Period
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Transfer to Charity prior to sale avoids tax on gain
Payment to Charity does not avoid tax on gain
Charitable deduction
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Outright gift
Gift annuity
Charitable Remainder Trust
Gift can be from 0 – 100%
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Preferred investment options
Debt to pay
Better financing options for next generation◦ Interest rate
◦ Length of repayment
Lower tax bracket in future years◦ 0%
◦ 15%
◦ 20%
Interest from next generation is better and/or safer return on sales proceeds
Assist next generation with financing
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Doesn’t want to pay the tax Wants to buy other real estate◦ Another farm for another child◦ Residential rental property for another child◦ Residential rental property(ies) for investment income◦ Commercial rental property(ies) for investment income◦ Investment real estate – Hunting cabin◦ Future home for themselves; must be rented first for several
years
If replacement property(ies) held until death, tax is avoided
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Capital gains tax avoided
Income tax charitable deduction
Depending on non-charitable beneficiaries◦ No inheritance tax
◦ No federal estate tax
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Stream of cash flow to income beneficiary – 5% minimum
Beneficiary can be:◦ Seller and spouse◦ Children and Grandchildren◦ Siblings
Wealth Replacement Trust funded with life insurance
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Pay 100% in year of sale
Pay over time in installments
Defer through a 1031 exchange
Avoid by giving to charity directly or through a Charitable Remainder Trust
Avoid by holding until death
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Annual Gift Tax Exclusion -$14,000 per recipient
Lifetime Gift/Estate Tax Exclusion - $5,450,000
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Beneficiary Tax Rate
Spouse and Charity 0%
Children and lineal descendants 4.5%
Siblings 12%
All others, including nieces and nephews
15%
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Generally, fair market value of assets owned
Life Estate
Exempt Transfers
◦ Life insurance proceeds
◦ Certain Farm Transfers (2012)
◦Qualified Family Owned Business (2013)
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Lineal descendants and siblings exemption
Business of agriculture exemption
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Transfer to or for the benefit of lineal descendants or siblings of:◦ Agricultural reserve, agricultural use property or a forest
reserve (similar to Clean & Green/Act 319)◦ An agricultural commodity, including any and all plant and
animal products, including Christmas trees produced in the state for commercial purposes
◦ An agricultural conservation easement
No annual certification or gross income requirements
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Transfer to or for the benefit of Members of the Same Family of real estate devoted to the Business of Agriculture provided that after the transfer:o The real estate continues to be devoted to the
Business of Agriculture for a period of seven years beyond transferor’s date of death and
o The real estate derives a yearly gross income of at least $2000.
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Leasing property which is directly and principally used for agricultural purposes to:
◦ Members of the Same Family or
◦ A corporation or association owned by Members of the Same Family
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Recreational activities such as, but not limited to, hunting, fishing, camping, skiing, show competition or racing
Raising, breeding or training of game animals or game birds, fish, cats, dogs or pets or animals intended for use in sporting or recreational activities
Fur farming
Stockyard and slaughterhouse operations
Manufacturing and processing operations of any kind
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Real estate leased to unrelated third parties
Real estate leased for non-agricultural purposes
Real estate used for non-exempt purposes, even if affixed to exempt real estate, must be valued separately and taxed
Commercial buildings not used in the business of agriculture
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Homes on real estate that otherwise qualifies for the exemption is presumed to be used in the business of agriculture.
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Any individual
Individual’s brothers and sisters,
Brothers and sisters of such individual’s parents and grandparents
Ancestors and lineal descendants of any of the foregoing
Spouse of the foregoing
Estate of the foregoing
Individuals related by half blood or adoption
Step children
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Certifies $2000 of gross income
Filed by every member of the same family who has inherited business of agriculture exempt real estate
Filed each year for a period of 7 years beyond the decedent’s date of death
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Since July 1, 2013, new exemption for qualified family-owned business
If requirements met no tax on business interests under $5,000,000
Use net book value Less than 50 full time employees In existence for at least 5 years prior to date of death LLC, Corporations, Partnerships, Limited Partnerships Rentals Annual Certification for 7 years
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Exemptions can work in duality
If farm is run in an entity and land still privately owned
Entity can be exempted as Qualified Family Owned Business
Land can be exempted under Business of Agriculture
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If the exemption was not claimed,
there is an opportunity to recover tax paid
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Pennsylvania Inheritance TaxRefund
Beneficiary % Refund
Children 4.5% $67,500
Siblings 12% $180,000
Others 15% $225,000
The refund on a farm taxed at $1.5 million
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Pennsylvania Inheritance TaxRefund
Refunds can be obtained three years after filing of tax or Department of Revenue determination of Inheritance Tax
Practically, can obtain refunds between 3 ½ years to 5 years after date of death
If the plan is to sell to the next generation between death of two spouses, then put asset into name of one spouse
Full step up in tax basis at death of first spouse
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Will
Trust for
Spouse
Proceeds to Children at 2nd Death
Farm - $0 Inheritance tax
Trust sells farm - $0 Capital Gain
$0 Inheritance tax
Five year look back period
Ineligibility period for Medical Assistance
Long term care insurance
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Healthcare Power of Attorney and Living Will
Power of Attorney for Financial Matters
Last Will and Testament
Beneficiary Designations
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Sole Proprietorship
Partnership
Limited Partnership (LP)
Limited Liability Company (LLC)
Corporation
Limited Liability Partnership (LLP)
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