December 2020 interest rates on GRATs, sales to defective grantor trusts, intra-family loans, and AFRs with split interest charitable trusts
Certain federal interest rates rose slightly in December 2020 while others stayed the same. The federal rate (“AFR”) applicable in December for the sale to a defective grantor trust, a self-canceling installment slip (“SCIN”) or a family loan with a term of 3 to 9 years (middle) The long-term rate (pa) is 0 , 48%, after 0.39% in November and after 1.69% in December 2019.
The December 7520 rate for use with estate planning techniques such as CRTs, CLTs, QPRTs, and GRATs is 0.6%, which is an increase of 0.4% in November and a decrease of 2.0% in December 2019.
The AFRs (based on compounding annual interest) used in connection with intra-family loans are 0.15% for loans with a term of 3 years or less, 0.48% for loans with a term of between 3 and 9 years 1.31% for loans with a term of 3 years, term of more than 9 years.
For example, if a child is given a 10 year loan and the child can invest the funds and achieve a return greater than 1.31%, the child can achieve a return greater than 1.31%. The same phrases are used in connection with sales to defective grantor trusts.
Federal and state elections change tax policy
The November 3rd elections will have a far-reaching impact on tax policy.
As expected, Joe Biden won the presidential election. But Republicans exceeded expectations, taking multiple seats in the House of Representatives and capping their Senate losses. For President Biden, it will be difficult to push the controversial tax legislation – for example a reduction in inheritance and gift tax exemptions or the abolition of the “tightened” income tax base – through a narrowly divided Congress. Biden’s leverage will depend in part on the outcome of the two Georgia Senate runoff elections scheduled for January 5, 2021.
Meanwhile, voters in several states voted on tax voting initiatives.
In California, voters rejected Proposition 15, which excluded commercial and industrial buildings from the restrictions imposed by Proposition 13 (1978). However, California voters also approved Proposal 19 (which is discussed in more detail below), which makes it difficult for individuals to pass their low property tax bases on to their children or grandchildren.
Lucero v Commissioner, TC Memo 2020-136 (Finance Court, September 29, 2020)
Ronald Lucero owned a short term rental property in Sonoma County, California. A real estate management company ran the day-to-day operations of the property, even though Mr. Lucero drove from his Sacramento home to the property six to eight times a year to perform maintenance and purchase items for the property. Mr. Lucero and his family stayed on the property for a week around Christmas each year. On his 2014 income tax return, Mr. Lucero reported income from the property of $ 26,223 and expenses of $ 41,854 for a net loss of $ 17,631. On his 2015 income tax return, Mr. Lucero reported income from the property of $ 26,710 and expenses of $ 51,200 for a net loss of $ 24,490. The IRS did not allow either of these losses.
The IRS put forward two theories as to why the losses should not be allowed. First, the IRS argued that the property was a personal residence and therefore, under Section 280A, Mr. Lucero was barred from making any loss related claims. The tax court disagreed, ruling that a property within the meaning of Section 280A is considered personal residence if the taxpayer has kept it for an extended period of (a) 14 days and (b) 10% of the number of days that the taxpayer rents it out in a given year. The IRS was unable to establish that Mr. Lucero used the property as personal residence for more than seven days a year.
Second, the IRS argued that rental income was subject to Section 469’s passive loss limitation, which limits a taxpayer’s deductible losses from “passive activities”, that is, activities in which the taxpayer was not “substantially involved”. Passive losses must not exceed the taxpayer’s passive income, but any excessive loss can be carried over to the following year. Typically, rental activities are considered passive. However, when tenants rent a property for an average of seven days or less and the taxpayer is significantly involved in running the rental, the rental activity is considered active. In this case, the property was rented for less than seven days on average. So it all came down to whether Mr Lucero was significantly involved in the rental process. Substantial participation requires that a taxpayer be regularly, continuously and significantly involved in the activity. After the litigation began, Mr. Lucero attempted to reconstruct his activities on the property by keeping a time log based on invoices and receipts. The tax court, which dismissed the minutes as unreliable, found that Mr. Lucero had provided no evidence of material involvement in the rental activities and had therefore joined the IRS.
Note 2020-75
The Tax Cut and Jobs Act (“TCJA”) has capped state and local tax deductions (“SALT”) for individual taxpayers to $ 10,000 while businesses can continue to make unlimited SALT deductions. After the TCJA went into effect, a number of states revised their income tax laws to allow owners of “pass-through” businesses, that is, businesses that pass their income tax liability on to their owners, such as: B. Partnerships and S. Corporations – tax at company level and thus circumvent the SALT upper limit for individual taxpayers. On November 2nd, the IRS effectively blessed this state effort. In the 2020-75 notice, the agency announced that it would enact regulations that would allow eligible owners of transit businesses to deduct the full amount of all business taxes.
California’s Proposal 19
Proposal 19 was passed in the November elections. There are a number of changes to California law that affect parents’ ability to transfer real estate to children without their being revaluated for property tax purposes. The law applies to property transfers after February 15, 2021.
Existing law Pre-Prop 19
Prior to Prop 19 taking effect, parents were allowed to transfer real estate (including trusts in their favor) to children in two circumstances without the transfer being viewed as a “change of ownership” for property tax purposes. This means that the transfer can take effect if the adopting child retains the property tax base of the adopting parent. In English, this means that property taxes would remain unchanged.
These two circumstances were:
- Any transfer of primary residence to children (or trusts in their favor) was completely exempt from property tax revaluation (the “Primary Residence Exemption”). Children did not have to live in the residence after the transfer for this exception to apply.
- Any transfer of up to $ 1,000,000 of the estimated value of other properties to children (or trusts in their favor) was also exempt from property tax revaluation (the “Other Property Exemption”).
The exemptions only applied to real estate transfers, not stakes in companies that own real estate. Because of this, some parents kept properties outside of entities so that these exceptions were available to them.
Prop 19 changes
Proposition 19 removes the exception for other properties in its entirety.
The main residence exemption is limited in two ways:
- Children must reside in their primary residence after the transfer to be eligible for the exception.
- If the increase in the value of the primary residence at the time of transfer is less than $ 1,000,000 more than its estimated value while the children reside in the residence after the transfer, there will be no property tax revaluation. However, if the increase in the value of the primary residence at the time of transfer is more than $ 1,000,000 above its estimated value, the property will be revalued at its fair value minus $ 1,000,000 (as long as the children reside there after the transfer). (The $ 1,000,000 amount is adjusted every year for inflation as per the law.)
If you want to make a transfer that uses the existing rules before Proposition 19 goes into effect, you should do so before February 16, 2021.
Wealth Management Update
The content of this article is intended to provide general guidance on the subject. You should seek advice from a professional about your particular circumstances.