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Monday, May 14, 2018

Reasons to set up a Third Party Supplemental Needs Trust as an Accumulation IRA Stretch Trust

In a previous post, I described the Reasons to Set up a 3rd Party Supplemental Needs Trust as an Irrevocable Life Insurance Trust.  The same Third Party Supplemental Needs Trust can also be set up as an IRA Stretch Trust

 If a Special Needs person is named as beneficiary of an IRA, 401k, 403b or any other asset, that could ruin their ability to qualify as for SSI and Medicaid.  However, paying retirement money to a traditional Third Party Supplemental Needs Trust can cause income tax problems.  Accordingly, we usually recommend that the Supplemental Needs Trust be created with provisions that allow a slow withdrawal of the retirement account over the lifetime of the beneficiary into a trust for the following reasons:
  • A traditional Third Party Supplemental Needs Trust can be named as a beneficiary of a retirement account, however, that is usually very tax inefficient from an income tax perspective as the IRS will require the retirement money to be paid to the trust within 5 years, and it will be taxed and the very high trust rates.  
  • To minimize income tax consequences, the trust should be designed as a modified IRA Stretch Trust.
  • An IRA Stretch Trust requires the Trustee to withdraw a certain amount each year from the retirement accounts which name the trust as the beneficiary.  The amount the Trustee is required to withdraw from the retirement account into the Supplemental Needs Trust is known as the Required Minimum Distribution (RMD) Amount.  The Required Minimum Distribution Amount is a based upon a formula set by the IRS that is tied to the life expectancy of the beneficiary of the trust (the Special Needs person). 
  • By taking out only the RMD each year, the IRA can continue to grow tax deferred. After the trustee withdraws the RMD from the retirement account into the Third Party Supplemental Needs Trust, the trustee may leave the money in the trust or distribute it to the Special Needs person subject to the normal limits of Special Needs Trusts.  
  • PLANNING NOTE: This should never be set up as a Conduit Stretch Trust as that will ruin the benefits of the Special Needs Person.  A Conduit Stretch Trust requires the RMD be distributed to the beneficiary every year.
  • PLANNING NOTE: In order to establish the Special Needs Person's life as a measuring life for IRS tax purposes, and have the Third Party Supplemental Needs Trust be treated as an Accumulation Trust, upon the death of the Special Needs Person, the balance of the trust and the retirement money can ONLY be paid to a person who is younger than the Special Needs Person.  
  • PLANNING NOTE: If you think that the client may wish to benefit an older sibling of Special Needs Person, consider making that older sibling the measuring life.
One downside to naming a properly designed Third Party Special Needs Trust with accumulation provisions as the beneficiary of a retirement account is that the income tax rates for trusts is higher than that of an individual.  However, if you wish to engage in special needs trust planning and provide a special needs person access to money from a retirement account, this appears to be one of the most tax efficient ways of doing so while also preserving the the government benefits of the special needs person.  

It should be noted that when doing Special Needs Trust Planning, sometimes, if parents have more than one child, they will name name a non Special Needs child as beneficiary of retirement money and a trust for the Special Needs Child as beneficiary of other assets. This is a completely viable alternate type of plan, but care should be considered regarding what happens if that other child predeceases the parents.

Friday, March 16, 2018

Reasons to set up a 3rd Party Supplemental Needs Trust as an Irrevocable Life Insurance Trust

Recently, I wrote a post explaining the differences between a First Party Special Needs Trust and a Third Party Supplemental Needs Trust.  As you are aware, the goal of a Special Needs Trust or a Supplemental Needs Trust is to provide financial resources to a Special Needs Person in a way that will not cause them to lose their government benefits, like Medicaid. Today, I wanted to explore the benefits of a Third Party Supplemental Needs Trusts in more depth.

A Third Party Supplemental Needs Trust can be created under a Will or it can be created as a stand alone trust by the parent or grandparent.  We usually recommend that it be created as a stand alone Irrevocable Life Insurance Trust for the following reasons:
  • Money/Insurance held by the Third Party Supplemental Needs Trust will pass free of estate tax and inheritance tax.  However this may not be a concern for federal estate taxes if your assets are below the current threshold of $11.2 million.  (Remember, the federal estate tax gets reduced to $5 million dollars, indexed for inflation, in 2026.)  
  • Other relatives who wish to benefit the special needs child can name the stand alone trust as a beneficiary under their Will or as beneficiary of a life insurance policy. This is important because otherwise each parent, grandparent, aunt, uncle and sibling that may want to benefit the special needs person would have to set up their own special needs trust, creating complexity and extra costs.
  • We frequently recommend that parents of a Special Needs child purchase a permanent life insurance policy to guarantee money will be there for the Special Needs Child as other assets may dissipate. 
  • A Third Party Supplemental Needs Trust and Life Insurance Trusts are protected from creditors of both the parents and child.
  • Creating a stand alone trust during your lifetime generally avoids the need to get the Court involved.  This can come up in various different ways:
    • Every time the trustee of a Trust created under a Will changes, it requires Court permission.  This is not true of a trust that is created as a stand alone trust.  A change of trustee of a stand alone Third Party Supplemental Needs Trust or Life Insurance Trust can be accomplished very easily and usually without having to go to Court if the documents are drafted properly.
    • If the trust needs to be modified or moved to another jurisdiction, the document can provide mechanisms for these changes without getting Court permission.  A frequent reason to move a trust is to get better protection or lower the income tax consequences.
  • The beneficiary of a stand alone trust has access to funds more quickly than if it were to go through an estate administration under a Will. (Probate can take months or even years.  If a Special Needs Person is reliant on a certain amount of monthly funding, naming a Third Party Supplemental Needs Trust as the owner and beneficiary of any insurance policy can be a tax efficient and quick way to guarantee that money will be available in a manner that will not cause the Special Needs Person to lose his or her government benefits.
NOTE: A stand alone trust is frequently referred to as an Inter Vivos Trust.  There are many types of stand alone trusts, including Revocable Trusts.  So while a Third Party Supplemental Needs Trust can be set up as a Revocable Trust, we usually recommend it be established in the same manner as an irrevocable life insurance trust for tax reasons.   

As you can see, there are many benefits to creating a Third Party Supplemental Needs Trust during your lifetime, rather than having it created under your Will.  If you have any questions regarding the best way to set up a Supplemental Needs Trust or a Special Needs Trust for a loved one, please don't hesitate to contact one of our estate planning attorneys.

Sunday, February 25, 2018

Understanding the Differences Between Special Needs Trusts and Supplemental Needs Trusts

"Special Needs Trusts" and "Supplemental Needs Trusts" are terms to describe trusts designed to provide benefits to a person in a way that will preserve the public benefits that he or she is entitled to receive. These types of trusts are most commonly created when a person has some sort of special needs or disability.  The person who benefits from the trust is called the beneficiary.

In New Jersey, Pennsylvania and Florida, the terms "Special Needs Trusts" and "Supplemental Needs Trusts" are often used interchangeably, although they should not be as it often results in serious problems.  I personally try to use the term "Special Needs Trust" as a way to refer to a First Party Special Needs Trust (i.e. the money used to fund the trust belongs to the special needs person). I try to use the term "Supplemental Needs Trust" to refer to a Third Party Special Needs Trust (i.e. the money used to fund the trust belongs to someone other than the Special Needs Person).

Both a First Party Special Needs Trust and a Third Party Supplemental Needs Trust are intended to protect different public benefits. Most disabled individuals and special needs individuals receive Supplemental Security Income (SSI), Medicaid, vocational rehabilitation, subsidized housing and food stamps.  The most important rule for all First Party Special Needs Trusts and Third Party Supplemental Needs Trusts is that the trust may not pay cash to the beneficiary and it may not pay to or for the benefit of the beneficiary for any medical needs covered by Medicaid, food, shelter, or any asset which could be converted into food or shelter.

A First Party Special Needs Trust and a Third Party Supplemental Needs Trust allow the beneficiary to continue to receive government benefits, but also have money for clothing, education, travel, cable and cell service, electronics, furniture, personal care, medical care not covered by Medicaid, and many other items that make life worth living. 

Key features of a Third Party Supplemental Needs Trust:

1.  It is a Discretionary Trust
A Discretionary Trust is a Trust that allows the trustee to give money for the benefit of the Special Needs Person as the trustee sees fit.  If the trustee has complete discretion whether to make distributions for the beneficiary, the trust principal and income will usually not be counted as available to the beneficiary for purposes of obtaining government benefits.

2.  Established using funds of someone other than the Special Needs Person
A Supplemental Needs Trust is most common when a parent, grandparent or other relative wants to leave money for the benefit of a Special Needs Person.  Care must be taken to avoid giving that person money outright, otherwise he or she risks losing public benefits.  The Supplemental Needs Trust is a way for third parties to provide a Special Needs Person access to money in a way that will not cause them to lose their benefits.

3.  No government payback upon the death of beneficiary is required
After the Special Needs beneficiary passes away, Medicaid does not require reimbursement for the funds it expended during the lifetime of the beneficiary if the trust is funded DIRECTLY with the money of someone other than the beneficiary.  Please note that if a parent leaves money to a child and then the child sets up a trust, that will be considered a First Party Special Needs Trust, and not a Third Party Supplemental Needs Trust.  The key difference is that the third party must set up the trust AND fund it to qualify as a Third Party Supplemental Needs Trust.

4.  A Supplemental Needs Trust can have more than one Beneficiary
While there are substantial restrictions on how the Special Needs Person can receive money, because the trust fund is not comprised of funds of the Special Needs Person, there are few guidelines on how the rest of the Supplemental Needs Trust can be administered. Accordingly, the sole benefit rule that applies to First Party Special Needs Trusts does not apply to Third Party Supplemental Needs Trusts.  As government benefits are available only to those with financial need, the most important rule is that the beneficiary should never be entitled to the money in the trust.

5.  Taxation of Third Party Supplemental Needs Trusts
A Third Party Supplemental Needs Trust can be established as a Grantor Trust while the Grantor is alive, a Qualified Disability Trust or a complex trust.  If the trust is set up as a Grantor Trust, income generated by the trust will be allocated to the Grantor (or Creator) of the Trust during his or her lifetime.   If the trust is taxed as a complex trust, the trust will pick up most of the tax consequences in these types of trusts. Designing the trust as a Qualified Disability Trust may offer a small tax break, but it offers less privacy.  Often privacy is better than saving a few dollars in taxes as it can reduce confusion by government officials looking into the benefits and income of the Special Needs Person.  When fewer people question the validity of the trust, that saves legal fees and aggravation.

Key features of a First Party Special Needs Trust:

1.  It is a Discretionary Trust
A Discretionary Trust is a Trust that allows the trustee to give money for the benefit of the special needs person as the trustee sees fit.  However, payments to any one person or entity in excess of $5,000 during a single calendar year requires government approval.

2.  Established using funds of the Special Needs Person
A First Person Special Needs Trust is most commonly created when a person inherits money outside of trust or is awarded money in a personal injury settlement.  Prior to actually receiving the money, the Special Needs Person can create this type of trust to avoid losing their public benefits.

3.  There is a government payback at the death of the Special Needs Person
After the Special Needs beneficiary passes away, the government requires that the First Party Special Needs Trust reimburse Medicaid for expenses it has incurred.  For this reason many trust specialists semi-jokingly recommend that the trustee of a First Party Special Needs Trust try to spend the last dollar of the Trust on the day the Special Needs Person dies.

4.  A First Party Special Needs Trust must be for the sole benefit of the Special Needs Person
The sole benefit rule of a Special Needs Trust is very tricky and many states, including New Jersey, have changed their definition of this term many times over the years.  For example, can payments be made for the care of a pet for a Special Needs Person?  Many New Jersey officials say no, but most will also say yes, if it is a therapy animal. The biggest issue comes up over incidental benefits.  For example, a First Party Special Needs Trust can pay for a Special Needs Person to go to an amusement park, but it shouldn't pay for the ticket of a family member caretaker even that caretaker has no interest in going to the park and is only going to assist the Special Needs Person.

5.  Establishing a First Party Special Needs Trust.
Creation of a First Party Special Needs Trusts is much more complicated than the creation of a Third Party Supplemental Needs Trust. Usually (but not always), a First Party Special Needs Trust must comply with a federal law enacted in 1993. That law requires that most First Party Special Needs Trusts be established by a judge, a court-appointed guardian or the parents or grandparents of the beneficiary with notification being given to the government so that they can appropriately monitor it.(In some cases Social Security regulations may also require a judge to sign off on the creation of trusts).  In addition, the trust must generally be created before the beneficiary turns 65 years of age.

6.  Alternate names of a First Party Special Needs Trust
First Party Special Needs Trusts are frequently referred to as d(4)(A) Trusts because that is the section of the government statute that allows for these trusts.  They are also frequently called self settled special needs trusts.

7.  Taxation of First Party Special Needs Trusts
Because this is a grantor trust for IRS tax purposes, all income earned by the trust is taxable to the Special Needs beneficiary. There is no option to tax the trust itself.  The trust is also includible in the gross estate of the Special Needs Person for estate tax purposes.  However, the trust still need its own separate EIN and must file a federal Form 1041.  (Note: This can be a very simplified form merely advising the IRS that the Grantor/beneficiary will be picking up all the taxable income on their personal income tax return.)

8.  Other Issues with First Party Special Needs Trusts
Income generated inside a properly created 1st Party Special Needs Trust should not affect the beneficiary’s eligibility for government programs.  However, while taxable income is not “countable” income for purposes of Medicaid or other government benefits, government agencies often get a “tracer” report from the IRS about the beneficiary's income, and may issue a notice that benefits will be terminated unless they receive proof that the beneficiary did not have countable income. The trustee must be prepared to explain that although the income was reportable to the IRS as the beneficiary’s income for tax purposes, the beneficiary only received "in-kind” distributions that should not be counted as income for purposes of SSI, Medicaid, or other programs.  In other words, the Trustee will likely have to explain to many different people that the Special Needs Person is being taxed on income that the beneficiary never receives.


The administration of First Party Special Needs Trusts and Third Party Supplemental Needs Trusts can be somewhat difficult. A special needs trust attorney, familiar with public benefits programs and special needs trust provisions, should always be involved in the preparation of a Special Needs Trust or a Supplemental Needs Trust. While many legal matters can be undertaken without a lawyer, or with a lawyer with a general background, special needs planning is complicated enough to require the services of a specialized practitioner.

Monday, February 19, 2018

What Happens to My Facebook When I Die? : How to Choose a Facebook Legacy Contact 

It’s probably not surprising to learn that Facebook has become the most widely-used social media outlet in the world, boasting over 2 billion active users as of late 2017(1). The social networking giant is unique in that it caters not only to the younger Gen-X & Millennial demographics, but also to those born before: 79% of online adults ages 30 to 49 in the U.S. use Facebook, and about 56% of online Seniors age 65 and up use the site as well(2).
Facebook is a regular part of the daily lives of 53% of Americans
(3), but what happens when we pass away and leave our profile behind, locked with password that is most likely a total mystery to others? Previously, when Facebook learned of a death, it would “memorialize” the account, which left it viewable, but unable to be managed by anyone. However, Facebook has recently introduced a “Legacy Contact” feature that allows users to designate a Facebook friend to manage their account after they pass away.
Upon telling Facebook that someone has died (by submitting a
memorialization request), Facebook will memorialize the account and the pre-chosen Legacy Contact will be able to write a post to pin at the top of the Timeline, respond to new friend requests, and update the profile picture and cover photo. However, the legacy contact will not be able to see the private messages of the original user. 

If you’re into planning ahead, here’s a step-by-step guide to designating a Legacy Contact for your Facebook: 

1, Once logged in, select the triangle in the upper right-hand corner of the screen. On the drop-down menu that appears, click Settings.

2, On the General Account Settings page, at the bottom of the list of options, click on Manage Account. This will expand the box, and you’ll be able to type in the name of the Facebook friend who you’d like to be your Legacy Contact. Click on their name when they pop up. Please note that you can only select someone who is your friend on Facebook.

3, A small window will appear with the option to send a message to your Legacy Contact letting them know that you’ve selected them. You can choose to edit and Send the message, or hit Not Now if you want to talk with them about it later. 

4, Once you’ve selected your contact, you may choose to check (or not check) the Data Archive Permission box, which will allow your Legacy Contact to download a copy of things you’ve shared on Facebook, including photos, videos, and other public info. Your contact will NOT be able to access your private messages.
You may also choose to simply have your account deleted after your death by selecting Request account deletion.

Selecting a Legacy Contact via Facebook is a very simple process and worth considering if you would like to be able to have your photos, words, and memories immortalized….or at least, downloaded and saved by those you love for years to come.

Special thanks to Chelsea Robinson for researching and writing the vast majority of this article.

Wednesday, November 29, 2017

Benefit of a Life Insurance Trust after the Repeal of NJ Estate Tax

As we get closer to the repeal of the New Jersey Estate Tax on January 1, 2018, it is important to remember that New Jersey has NOT gotten rid of its inheritance tax.  Accordingly, if you wish to leave money to brothers, sisters, nieces, nephews, friends or a significant other (besides a spouse) and if you have life insurance, you should explore whether a trust is a good option.

Here's generally how the NJ Inheritance Tax works.  There is no inheritance tax on money going to charities or Class A Beneficiaries.  Class A Beneficiaries include: 

  1. A spouse (or civil union partner or a registered domestic partner);
  2. Lineal ascendants (parents, grandparents, etc.);
  3. Lineal descendants (children, grandchildren, great-grandchildren, etc.) and
  4. Step-children (but not step-grandchildren)

New Jersey excludes a number of items from the inheritance tax.  Specifically, the major items are excluded from the NJ Inheritance Tax are:

  1. Real estate or real property owned outside of NJ (Note that if you own a co-op, you technically do not own real estate, you own stock, which is intangible asset that is subject to the NJ inheritance tax.); 
  2. Money recovered under the NJ Death Act (as compensation for wrongful death); and
  3. Life insurance that is payable to anyone except to a person's estate.

As you can see, when it comes to life insurance, if you ultimately want money going to brothers, sisters, nieces, nephews, friends or a significant other, you don't want to name your estate as the beneficiary (even if it filters through a Will) because it results in a NJ inheritance tax.

Now, the easy and obvious solution in most cases is that you can simply fill out a beneficiary designation form for the life insurance policy and name the people that you want, and then the death payout will be excluded from the NJ Inheritance Tax.  However, many people want to create more complex arrangements.  Here are some situations in which it is likely worth the time and expense to set up a trust:

  1. If you want to set money aside for the benefit of an elderly parent or special needs relative, but upon their death, want the balance to go to other people.
  2. If you want to have a complex formula for who gets your assets.  (For example: If Person A and B are alive, they get 30% each and person C gets 40%, but if A or B is not alive, then person C gets their share.)
  3. If you don't want to let the beneficiary of your policy have immediate access to the money upon your death.  Let's say you want to leave money to a niece or nephew, but they are a minor, so you want them to have money for college, but not play money until later in life.  A trust is especially good here if you don't trust your sibling to manage the money.
  4. If you have multiple policies and many beneficiaries, you may not want to update all the policies every time you change your mind regarding who the beneficiaries should be.  If you name the trust as beneficiary, you can just change the trust and you won't need to redo beneficiary designation forms at multiple institutions.
  5. If you want to name certain people as beneficiaries, but you don't want them to know.  (Keep in mind that some insurance companies ask for Social Security Numbers of the beneficiaries and you may not want to ask people for that, or they may want to know why.  With a trust, you don't even need to have that conversation.)
  6. In divorce settings.  Let's say you are obligated to pay life insurance to a ex-spouse, for a certain period of time, or based upon a formula.  You can name the trust as the beneficiary, and put the formula in the trust.  The alternative is revising your policy each year.

Remember, in many of the scenarios above, you can simply create a Will that sets up a trust, but if you name the estate as the beneficiary, it causes the inheritance tax.  If you set up the trust before you die, and name the trust, it won't cause an inheritance tax.  It is also very important to realize that if you are only worried about avoiding the NJ inheritance tax, it does NOT have to be a traditional irrevocable life insurance trust.  This means that if you even have a traditional revocable trust and name that as the beneficiary of your policy, it avoids the NJ inheritance tax.

Thursday, November 9, 2017

Change to Estate Tax Exemption Limit for 2018

While the House and Senate are considering competing tax proposals, including a proposal to eliminate the federal estate tax, it is worth noting that the IRS has release Revenue Procedure 2017-58 which provides inflationary updates for a number of provisions in the Internal Revenue Code.

Assuming that the Republicans do not pass a bill that modifies the existing estate tax and gift tax structure, for 2018:

  1. US Citizens and Permanent Residence Aliens can pass on $5,600,000 per person upon death or during their lifetime.  The federal estate tax exemption is also known by several other terms including the lifetime gift exemption, the basic exclusion amount, and the unified applicable exclusion amount.   The exemption is being increased by $110,000 from its 2017 limit of $5,490,000;
  2. The annual gift tax exclusion will increase to $15,000 per person, per donee.  This is up from $14,000 in 2017; and
  3. The annual exclusion for gifts made to a non U.S. Citizen spouse has been increased to $152,000.  This is up from $149,000 in 2017.

This revenue procedure does not change any laws.  It is simply designed to inform taxpayers of any changes in tax provisions as a result of inflation. 

Friday, November 3, 2017

Proposed Tax Policy By Republicans Would Enable Wealthy to Pass On A Massive Income Tax Deduction to Their Heirs Upon Death

As most of you know, I generally try to avoid political discussions and I really try to avoid commenting on proposed tax policy before it becomes law for the simple reason that most proposed law changes never get enacted.  However, I feel compelled to talk about what I believe is a major flaw in the proposed “Tax Cuts and Jobs Act”.

Before I do, I think it is important to have a quick discussion on the background of estate and gift taxes, social policy and the purpose of an estate tax.  As many of you know, the United States has a 40% federal estate tax and gift tax that kicks in when someone transfers assets in excess of about $5.5 million (either upon death or through gifting).  Note, the amount that can be passed on tax free is doubled for married couples.  Additionally, there is no tax when one spouse dies and leaves assets to a surviving citizen spouse.  So to be clear, the estate tax currently affects very few people, about 5000 per year.

Proponents of an estate tax feel that it is a socially beneficial tax because it prevents wealth from being concentrated in the hands of a few.  Moreover, because wealth generally equals power, it also means that you are avoiding concentrating power in the hands of just a few individuals.  Opponents of an estate tax feel that if a person has already been taxed on their income, they should be able to do what they want with the money, including giving it away to their heirs without having to pay another tax.  They also object to the fact that frequently a decedent’s wealth is illiquid, because they own real estate or a business, and they are forced to sell assets off in order to pay the taxes.

However, I won’t go into the merits of either argument, as that is not the purpose of this article.

Specifically, my concern is that under the new tax act proposed by the Republican party leaders, they would like to repeal the federal estate tax while maintaining both the step-up in basis provisions under Section 1014 of the Internal Revenue Code and the ability of taxpayers to depreciate their rental property under Section 179. 

In order to understand the gobbledygook that I just said, you need to understand depreciation and you also need to understand basis. The simplest way to understand depreciation is that the government gives you the ability to deduct the cost of an asset over its useful life.  Different assets have different depreciation schedules.  For purposes of this article, you should know that rental property (but not the land) can depreciated over 27.5 years.  So, if you purchased land and a building for $4 Million, and the building was worth $2.75 million, you would be able to deduct $100,000 per year on your taxes for close to three decades.

The simplest way to understand basis is that the basis of an asset is generally the price you pay for something.  In other words, if you pay $20 for Apple stock, your basis is $20.  If you sell it for $100, you have an $80 gain.  With a 20% capital gains tax rate, the tax on that would be $16.

Basis in real estate is more complex because it is increased by capital improvements and decreased by depreciation.  So if you bought that building for $4 million, and spend $200,000 fixing up the bathrooms, the new basis will be $4,200,000.  (Let’s allocate $2.95M to the building and $1.25M the rest to the land.)  If you sell it for $5 million, there will be $800,000 of gain.  To take this example further, let’s say you have been renting this building out for 30 years and depreciated it that entire time, you would have received a tax deduction for about $110,000 each year.  However, because you had depreciated the property, the basis in the land would still be $1.25, but the basis in the building would be $0.  Therefore, upon a sale, there would be a total gain of $3.75M.  Equally as important, $2.95M of that gain would be treated as ordinary income and the balance would be treated as capital gain.  (Total taxes of about $1.4 million.)

Under the current tax laws, whenever a person dies, the beneficiary of that person’s estate receives a new basis in all assets owned by the decedent.  This concept is known as receiving a step-up in basis.  The original policy reasoning behind allowing for a step-up in basis is that it would be unfair for a person to pay both an estate tax and a capital gains tax when the asset was sold. 

So in the example above, if you had kept that building until your death, it would have received a new basis equal to $5 million, then if your kids sold it for $5 million, there would be no gain on the sale, therefore would have been NO TAX.  As mentioned, the proposed tax law does not change this.
More importantly, since the heirs would receive the property with a stepped up basis of $5 million dollars, they could decide to depreciate it AGAIN and receive a tax write-off of close to $150,000 per year for another 27.5 years. 

The policy of having a step-up in basis makes sense so as to avoid a double tax, but it also makes sense because so many people have trouble tracking what they originally paid for things.  Accordingly, the government thought that a step-up would make it easier to track basis.  Back when the estate tax threshold was $1,000,000, everyone benefited from this step-up rule, and it was not a significant tax policy concern because wealthier individuals would be paying the estate tax instead of a capital gains or income tax.  Basically, back before 2001, only people with less than $1 million dollars could take advantage of this loophole.

Under the current law, people with assets under $5.5 million ($11M for married couples) can take advantage of this loophole, but the estate tax still prevents the ultra-wealthy from doing so. 

Under the tax law proposed by the Republicans, not only would the ultra-wealthy become eligible for this loophole, they could do it over and over again at every generation, meaning that you are effectively giving birth to a class of individuals who will be born with a tax deduction.  Literally passing on a rental property to an heir means you would be passing on the ability to deduct have a reduced income for income tax purposes.  Taken to an extreme, this would consolidate wealth and power in the hands of a few individuals.  This will stifle social mobility as land will become the most valuable commodity and create a feudalistic system similar to what existed in Europe for ages.

As far as I am aware, all other countries that have an estate tax also have a step-up in basis rule to avoid a double tax.  Countries that do not have an estate, inheritance tax or some other sort of death tax, do not allow the basis of a decedent’s assets to be adjusted on death because that would mean a person’s assets could never be taxed.

The solution to this problem is quite simple though.  Keep the estate tax.  Alternatively, don’t allow a step up in basis upon death.  I am not currently suggesting that we remove the depreciation deduction provision as I believe that we should encourage people to buy property.  As long as they pay tax on it sometime, society will be fine.

In summary, the proposed tax law allows for the creation of a new and more powerful class of land owners by combining 3 tax breaks that were not meant to be combined:
  1. Repealing the estate tax (meaning that wealthy land owners pay no tax upon their death);
  2. Maintaining the Section 1014 step up in basis for all assets  - This means that if a real estate mogul purchased land and buildings for $20,000,000 and it was worth $200,000,000 at the time of the mogul’s death the heirs would inherit it at a new basis of $200 million.
  3. Allowing for depreciation of rental Property. During the mogul’s lifetime, he could depreciate the property get a tax deduction of over $700,000 per year and upon the mogul’s death, his heirs could do it again at a much higher level.
By combining these three provisions, the heirs described above would receive a property worth $200 million tax free. They could then either (i) sell the land and buildings for $200 million dollars and never pay any estate tax, income tax or capital gains taxes; or (ii) keep the real estate and depreciate it from its new stepped up basis of $200 million, not just the original $20 million purchase priceThe heirs of mogul, after paying no taxes ever on this property, would be able to receive approximately a $6 million annual tax break for doing nothing other than inheriting property!

What makes this amazing is that this can happen at EVERY GENERATION! Each time a parent passes away, the heirs would inherit tax free and then they would get to depreciate the property with a new increased basis. People would literally be born into a situation where they are inheriting millions of dollars worth of tax deductions.