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Getting Ready to Watch the Sunset

We continue our series on The Wealth Cycle with a discussion on the sun-setting of major provisions in the US Tax Code that will become effective on January 1st, 2026, less than 18 months from now. Catch up on the series below.

Read the Previous Posts in This Series:

A little background first. In 2017, Congress passed legislation known as the Tax Cuts & Jobs Act (TCJA) to stimulate economic activity. The law lowered the corporate tax rate for C-Corps from a top rate of 35% to 21% and also reduced taxes for most pass-through entity owners. It also authorized generous bonus depreciation deductions for plant, equipment and R&D expenditures to stimulate capital investment. Personal income tax rates were lowered and the exemption threshold for the estate tax was significantly increased. Without taking too deep a dive into the details, most of the law’s provisions expire on December 31, 2025 and return to where they were before the TCJA passed. Not good at all for those who carry the bulk of the tax burden for the country. We are talking trillions here.

It is the estate tax exemption threshold we focus on today because a failure to take immediate action related to it could result in the unnecessary payment of millions of dollars in estate taxes in the future.

Before the TCJA passed, the estate tax exemption threshold for an individual estate was $5,490,000 (double that for joint estates). That meant that if an individual estate was worth less than the threshold, no estate tax would be due. If the estate was valued at $10,000,000, the first $5,490,000 would be exempt from tax, but the remaining $4,510,000 would be taxed at 40%, or $1,804,000 at the Federal level. Thankfully, California doesn’t have an estate tax.

The TCJA doubled the threshold for individual and joint estates, and then indexed it to inflation to keep it moving higher. In 2024, the individual threshold is up to $13,610,000 and the joint threshold is twice that, or $27,220,000. It will be indexed to inflation again in 2025, then go back down to approximately half of those amounts based on an inflation adjusted formula with $5,000,000 as a base for individual estates and $10,000,000 on joint estates. Experts estimate an individual exemption threshold of approximately $7,000,000 in the 2026 tax year, double that for joint estates.

So, in our example above, the individual estate worth $10,000,000 in 2026 would be subject to $1,200,000 (40% of $10 million minus $7 million) in federal estate tax instead of $0 today.

What can this person do to keep that from happening? The answer is to take advantage of today’s exemption threshold and reduce the value of the estate to below $7,000,000 by December 31, 2025. To do that he would choose an asset worth $3,000,000 or more to gift to his heirs now to get under the projected threshold. He would file a gift tax return so the IRS would be notified that he is using a portion of today’s threshold of $13,610,000, and his heirs would become the owner of the asset that we will say is an industrial building purchased 8 years ago for $1,500,000 and is currently leased to a local business paying fair market rent. 

This whole transaction would not be taxable at the time it was executed. The downside is the heirs get the donor’s basis, which means they would be subject to capital gains taxes if they sold it right away versus getting a full step-up in basis if they inherited the asset upon the death of the donor. But, they don’t have to sell it. They could hold if for the income or exchange it into other real estate assets at a time of their own choosing. If they held the building or other exchange property until their own death, their heirs would get a full step-up in basis and could sell right away without tax liability. 

The main objective here is to use today’s higher estate tax exemption threshold to your best advantage while it is still in the tax code. And, it’s yours for the taking, but not for long. The next 18 months will be gone in a flash. In the above case, it wiped out the estate tax altogether. But, even for individual and joint estate holders with estates well above even today’s threshold, it is better to use it all while it is available. Take an individual estate holder of $25,000,000. If he does nothing and dies after December 31, 2025, his estate would pay $7,200,000 in estate taxes ($25,000,000-$7,000,000 X 40%). If he uses his entire exemption before that date by gifting assets to those who will end up with them someday anyway, his estate would only pay $4,556,000 ($25,000,000-$13,610,000 X 40%). That’s a huge savings and may be well worth handing the heirs a lower basis.

So, we recommend that you take another good hard look at all your assets in terms of their current value and your basis in them. It just might make sense to execute a portion of your wealth distribution plan while you are still in charge. You might choose to gift assets with a higher basis to minimize the impact to your heirs and keep those assets with the lowest basis and pass them along with a full-step up when you pass away. Everyone’s situation is unique.

The foregoing is a high altitude look at a very complex area of the law. We are not tax or estate planning experts, but we know enough to know that the sun-setting of estate tax provisions in the TCJA is worthy of your attention and that of your financial advisors. We also know that virtually everyone who has owned industrial real estate in Southern California for any length of time is at or above either today’s or tomorrow’s estate tax exemption threshold. We can help you with valuing your real estate and stand ready to do so quickly and accurately. December 31, 2025 is a big day and it will be here in no time. This is your call to action, as millions of your hard-earned dollars could be at stake.

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