We’ve talked before in this column about how farmers invest the right way. They find an attractive investment – predominately land – and hold onto it through thick and thin. Over time, they earn quite respectable returns.
For that reason, I generally draw the conclusion that farmers are some of the very best investors.
Farmers, as a group, also tend to be excellent at two other endeavors: (1) growing plants and animals that power our bodies and our world, and (2) paying the absolute least amount in income taxes as humanly – and legally, hopefully – possible.
I’m not sure there is another class of United States citizens who despises paying income taxes as much as farmers.
Don’t get me wrong, they pay what they owe when it comes to income taxes. But they have ways of ensuring that what they owe is as pitiful as possible. They also take full advantage – as they should! – of another legal, and tremendously attractive, tax avoidance strategy allowed by our current tax code.
What is this strategy? It’s called “step-up in basis.” And it’s powerful.
Normally, when someone buys an asset and later sells that same asset, they owe tax if the asset has increased in value during their ownership. Those gains are taxed when the asset is sold.
However, there’s a quirk in the tax code. If you buy an asset and hold onto it until you die, as opposed to selling it or gifting it while you are alive, then the asset’s basis – i.e., the original purchase price of the asset, more or less – is “stepped up” to the fair market value on the owner’s date of death.
That is important because it means whoever inherits the asset enjoys a higher basis, which means lower taxes. As a result, if the person who inherits the asset sells it shortly after receiving it, no taxes would be paid on the gains. Why? Because there would be no gains for the person who inherited it. Their basis equals the fair market value.
Think about that. The original owner would not have paid taxes on the gains, nor would the person who inherited the asset pay them. The gains are simply tax-free.
That’s a wonderful deal for anyone owning assets that appreciate in value over time.
Farmers have that figured out better than almost anyone.
Fun fact: We’ve been living with the stepped-up basis doctrine for a century. Literally. Congress passed the Revenue Act of 1921, which clarified that the basis of an asset is stepped up to the date of death value of its owner, on November 23, 1921. So, 100 years and 20 days as of this writing.
But here’s the deal. Farmers aren’t the only ones who are eligible to take advantage of the stepped-up basis. Again, it applies to any asset that has appreciated and is held until the owner’s date of death.
That means houses, commercial real estate, business interests, collectibles, and – importantly – investments like stocks, are qualified to take advantage of this juicy tax-avoidance technique.
It’s just that most people don’t treat those types of assets the same way farmers treat land. Most people treat other assets as speculations, not permanent holdings.
If you hold an asset that you are happy to own for the rest of your life, then it can pay to hold onto it. In fact, because of tax implications, you might be worse off selling that kind of asset at the absolute highest price rather than holding onto it for life and giving it to someone else at a slightly lower value.
The best assets for stepped-up basis are those that are likely to appreciate over time and have limited potential to experience severe drops in value. And the assets must be taxable – not housed in a qualified investment account, like an IRA or 401(k).
Land often fits that bill perfectly. But so do many business interests and stock and mutual fund investments.
Take a lesson from farmers. When the tax code gives you an opportunity, don’t waste it.
Justin Lueger is President of Invisor Financial LLC, a registered investor adviser firm in the State of Kansas. All opinions expressed are his own and should not be viewed as individual advice. He can be reached at justin.lueger@invisorgroup.com.