Many in the wine industry are part of a legacy, or hope to create one, where properties and business interests are ultimately passed down to the next generation and beyond. While many plan to pass these long-term assets along at their death, there may be a unique opportunity to create a larger legacy at death by transferring property now, as a result of low valuations. The current market conditions may not be the most favorable for business, but low valuations can make it a favorable time to engage in long-term wealth transfer planning. 

Efficient Use of Gift and Estate Tax Exemptions

As a result of federal tax legislation passed this past year, every person now has a lifetime gift and estate tax exemption of $15 million, and married couples have a combined exemption of $30 million. The gift tax and estate tax exemption amounts are directly tied together, meaning that any taxable gifts made during a person’s lifetime directly affect their estate tax exemption amount. For gift and estate tax purposes, the fair market value of property is measured at the time of the transfer. When property values are low, more assets can be transferred using less of the gift and estate tax exemption amount. It is hard to plan for what market conditions and valuations may be at a person’s death. However, whenever there is a market dip that unusually lowers valuations, one wealth transfer strategy is to “freeze” the low valuations for estate and gift tax purposes through lifetime gifting.

For example, consider a vineyard property that was once worth $3 million, but is currently worth $2 million. The $2 million property is gifted in trust for the benefit of the owner’s children. Even as that property appreciates over time, the value of the donor’s gift for estate and gift tax purposes is “frozen” at $2 million. The result of this example is a preserved exemption amount that can now be used to pass on additional assets to the owner’s children (and others) tax-free. Any post-gift appreciation of the vineyard is removed from the donor’s estate and will accrue for the benefit of the child. Alternatively, assume that the owner continued to hold the property and at his death it had appreciated to $5 million; the additional $3 million would still be a part of his estate and would use up $3 million more of the exemption.

Enhanced Valuation Discounts

Gifting a portion of a closely held business, such as an LLC or limited partnership, is an effective strategy to both freeze the gifted portion’s current value and take advantage of valuation discounts. When there are multiple owners of a closely held business, valuation discounts will typically apply to that business, either for lack of control, such as when an owner holds a minority interest, or due to lack of marketability, because it is privately held or held by multiple family members. Combining these typical discounts with a downturn in the market could lead to favorably low valuations used to pass on a business. 

For example, if a married couple gifts one-third of a family business to a trust for the benefit of their children, not only should the gift receive a fractional interest discount, but also the interest that each spouse retains – one-third each – should receive a fractional interest discount at death (assuming these interests are not transferred before then). With discounts ranging between 25-40%, there are substantial amounts that can be transferred to the next generation using these techniques. 

Capital Gains Considerations

One of the biggest advantages of passing assets at death rather than during a person’s lifetime is the “step up” in basis to fair market value for capital gains tax purposes. One benefit of the step-up is that capital gain will only be realized on the difference in value between the date that the property is inherited and the date of sale. The other benefit is that, in the case of real property, depreciation schedules will restart.

Unlike assets passing at death, however, gifted assets carry over the donor's basis. If the donee later sells the asset that was gifted to them, capital gains tax may be owed on the entire appreciation from the donor's original purchase price (or since it was inherited by the donor). In addition, in the case of assets received by gift during the donor’s lifetime, the donee will not benefit from a new depreciation schedule at the donor’s death.

On the other hand, in instances where it is not the intention of the donor or donee that the asset will be sold in the donee’s lifetime, or where property was recently acquired (and therefore already has a high cost basis), or where real property is not a major asset of the family (and depreciation is not applicable), a step up in basis may be of little or no value to either party. Nevertheless, the effects of foregoing this advantage could be significant if the asset were later sold, and should be considered before it is gifted.

Property Tax Considerations

In almost any instance where real estate is being transferred to another person or entity, an owner needs to be very conscious of property tax laws so as not to trigger reassessment for property tax purposes. Special rules apply to legal entities and to property acquired before the passage of Proposition 13, and these rules should be reviewed carefully. Importantly, many properties are subject to the Williamson Act; in these cases, property tax reassessment may be a non-issue.  

Additional Considerations

Gifting for estate and gift tax purposes is irrevocable, and the donor should be comfortable with legally parting with the asset and its future appreciation before gifting the property. Extensive planning is usually needed before making large irrevocable gifts.  

Mark Weaver is a partner and Cami Fergus is an associate in Farella Braun + Martel’s Family Wealth Group. Farella is a law firm headquartered in San Francisco with a Napa Valley office focused on the wine industry. 

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