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Overview of Relevant Taxes

There are several taxes to consider when it comes to estate planning.

These taxes include:

Transfer taxes such as Federal Estate, Gift, and Generation-Skipping Transfer Taxes
California Real Property Tax; and
Capital Gains Tax

The ideal outcome is to optimize the estate plan to avoid or reduce the transfer taxes following a death, keep the annual property tax bill as low as possible when real estate is transferred following a death, and enable assets to receive a step-up in basis so that, if property is sold following a death, relatively little (if any) Capital Gains Taxes need to be paid.

Each of the above taxes will be described further below, along with estate planning considerations and techniques to avoid or reduce them.

Transfer Taxes

The transfer taxes to be considered in estate planning include Federal Estate and Gift Tax, and the Generation-Skipping Transfer Tax

Federal Estate Tax

The Federal Estate Tax is a tax levied on the transfer of a person’s assets after death. Fortunately, the law provides an exempt amount that can pass free of free of this tax. Therefore, only if a person’s assets transferred at death (plus any lifetime taxable gifts made, more on that below) exceed the applicable exemption amount will any tax be due. This is a very good thing, because the tax imposed is a 40% tax!

In 2024, the federal estate tax exemption amount is $13,610,000 per person. Keep in mind however, this exemption amount is subject to constant change based on the political climate and how the current law is written. In 2026, the exemption amount is set to revert back to $5,000,000 per person, adjusted for inflation.

For married couples, the applicable exemption amounts are doubled so long as the right estate planning techniques are used. These techniques include:

The use of a credit shelter trust (also known as an A-B trust or a bypass trust); where the deceased spouse’s exemption amount is applied to property transferred at his or her death; or
“Portability” of a deceased spouse’s unused exemption amount by electing it on a Federal Estate Tax Return

Federal Gift Tax

The Federal Gift Tax is a tax on any gifts made in excess of the annual exclusion amount in the year the gift is made.

The annual gift exclusion is $18,000 in 2024. Married couples can combine their annual gift exclusion amounts to make tax-exempt gifts totaling $36,000 to as many individuals as they choose each year, whether both spouses contribute equally, or if the entire gift comes from one spouse. In the latter instance, the couple must file an IRS Form 709 Gift Tax return and elect “gift-splitting” for the tax year in which such gift was made.

If a gift in excess of the annual exclusion amount is made, no tax is immediately due. Instead, the amount of the gift reduces the donor’s Federal Estate Tax exemption amount discussed above available at their death. In other words, the Estate and Gift Tax exemptions are combined. To the extent you utilize your lifetime Federal Gift Tax exemption while living, your Federal Estate Tax exemption at death will be reduced accordingly.

Generation-Skipping Transfer Tax (GSTT)

The GSTT is a transfer tax on property passing from one generation to another generation that is two or more generational levels below the transferor. For instance, a transfer from a grandparent to a grandchild or from an individual to another unrelated individual who is more than 37.5 years younger than the transferor.

Properly done, this can transfer significant wealth between generations.

The amount that can escape federal estate taxation between generations, otherwise known as the Generation-Skipping Transfer Tax Exemption is unified with the Federal Estate Tax exemption and the lifetime Gift Tax exemption at $13,610,000 per individual (and $27,220,000 for married couples, subject to certain specific requirements). As with estate and gift taxes, the top GSTT tax rate is 40%.

Important Detail on the GSTT Exemption and “Portability”

Married couples will not be able to use the GSTT exemptions of both spouses if they elect to use “Portability” as the means to secure their respective estate tax exemptions. A trust to which the exemption can be applied (such as a credit shelter trust or reverse QTIP trust) must be used. It is critical to work with a qualified estate planning attorney when GSTT is a factor in the estate plan.

California Real Property Tax

In California, property taxes are assessed on real estate. The tax is based on the assessed value from the county accessor’s office. Therefore, we want to keep the assessed value of our real estate as low as possible. (Note, assessed value is different than “market value,” which is what a willing buyer would pay.)

California Proposition 13 rolled back property values to their 1976 levels. Going forward, that base is preserved (subject to a maximum 2% annual increase) so long as the property is not sold or transferred in a way that causes reassessment.

When it comes to estate planning, wherever possible we want to be sure and avoid having our loved ones inherit property in a way that causes the property to be reassessed.

Transfers to a Spouse or Registered Domestic Partner Avoid Reassessment

Pursuant to California Revenue and Taxation Code Section 63, married spouses can transfer real estate to each other (during lifetime and at death) without causing reassessment.

Transfers of real estate between registered domestic partners are also excluded from reassessment.

Transfers Between a Parent and Child

Pursuant to Proposition 19, which was passed during the 2020 election year, transfers of property between a parent and child (either during lifetime or at death) occurring after February 15, 2021 can be excluded from reassessment only if the property qualifies as the primary residence of both the parent (at the time of transfer) and child (within 1 year of the transfer). Furthermore, the exclusion from reassessment is limited: The fair market value of the primary residence at the time of transfer cannot exceed the transferor’s assessed value by more than $1 million. If the fair market value at the time of transfer exceeds the transferor's assessed value by more than $1 million, the new assessed value will be the fair market value minus $1 million.

The transferee must claim the homeowner's exemption within 1 year of receiving the primary residence in order to receive the reassessment exclusion available under Prop 19.

Transfers Between Grandparents and Grandchildren

Pursuant to Proposition 19, qualifying transfers of property (either during lifetime or at death) between a grandparent and grandchild occurring after February 15, 2021 can be excluded from reassessment only if the grandchild’s parent was deceased, AND the property qualifies as the primary residence of both the grandparent (at the time of transfer) and grandchild (within 1 year following the transfer). Furthermore, the exclusion from reassessment is limited: The fair market value of the primary residence at the time of transfer cannot exceed the transferor’s assessed value by more than $1 million. If the fair market value at the time of transfer exceeds the transferor's assessed value by more than $1 million, the new assessed value will be the fair market value minus $1 million.

The transferee must claim the homeowner's exemption within 1 year of receiving the primary residence in order to receive the reassessment exclusion available under Prop 19.

Caution When Preparing Wills and Trusts

When drafting wills and trusts, certain provisions may cause property to be reassessed when it could have otherwise been exempt from reassessment. These provisions include where a trustee has the discretion pay trust income to a person or class of persons who aren’t excluded from reassessment (such as “issue” or grandchildren, nephews and nieces, etc.) as well as when a life estate is created in favor of someone who is not excluded from reassessment.

Avoiding Capital Gains Tax

Capital gains tax must be paid when property is sold if the sales price is higher than its cost basis. This tax is nearly as significant as the Federal Estate Tax discussed above.

Step-Up in Basis to the Rescue

In estate planning, property receives a step-up in cost basis to its fair market value if it is included in a person’s estate at their death. This is significant, because in many cases, a person who has died may have owned property for quite some time, and that property may have had a low cost-basis during the person’s lifetime. Therefore, when the basis is stepped-up at a person’s death, it can be sold with little or no capital gains taxes due.

Beware of Pitfalls that Cause a Loss of the Step-Up in Basis

There are estate planning pitfalls that can cause the loss of the above referenced step-up in basis which you should be aware of, these include:

When property is given to a person during lifetime (as opposed to at death) there is no step-up in basis. The recipient of the gift receives a carryover basis equal to that of the donor.
In the case of a married couple, when a credit shelter trust (often called an A-B trust or bypass trust) is used in the estate plan, assets in that trust will not receive a step-up in basis when the surviving spouse passes away. This type of trust is commonly seen in older trust documents that have not been updated, and can result in considerable tax consequences when those assets are ultimately passed on to children or other beneficiaries after a surviving spouse passes away.

Community Property Receives a Double Step-Up in Basis

When married couples or registered domestic partners own property as community property, a very unique set of rules apply. It is referred to as a double step-up in basis.

It works like this, community property (including community property in a trust) receives a full step-up in cost basis to its fair market value when the first spouse passes away. Contrast that with property owned as joint tenancy between spouses, where only 1/2 of the property would receive a step-up on cost basis.

With community property, each spouse’s share of the property gets a step-up to fair market value when the first spouse passes away (the “double” step-up). This provides a surviving spouse with a considerable tax benefit if community property is sold after the first spouse passes away.

Tip- Confirm the Community Status of Property as Part of the Estate Plan!

When doing estate planning, it is important to look at how couples own property to see if any steps need to be taken to confirm property as community property (such as creating new deeds or signing a marital property agreement). This is where working with an experienced estate planning attorney can really pay off.

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