Ihave to think I was in the clear majority of the country — I didn’t see much chance that Donald Trump was going to be elected president. What may have been even more astounding was that the Republican Party gained control of both chambers of the Congress. That sets the stage for some pretty major changes to our tax system that will have substantial effects on car collectors. Before getting into details, one important qualification has to be made. Since being elected, Mr. Trump has not really said much at all about what he has in mind for our tax system. […]
Ihave to think I was in the clear majority of the country — I didn’t see much chance that Donald Trump was going to be elected president.
What may have been even more astounding was that the Republican Party gained control of both chambers of the Congress. That sets the stage for some pretty major changes to our tax system that will have substantial effects on car collectors.
Before getting into details, one important qualification has to be made. Since being elected, Mr. Trump has not really said much at all about what he has in mind for our tax system. Everyone’s predictions are based on Mr. Trump’s campaign statements, his campaign website policy statements, various Republican Party policy statements, and a smattering of bills that have already been introduced but aren’t moving anywhere quickly. A lot can change between campaigning and legislating, but here is what the tea leaves seem to be saying.
Current law
Let’s start with a brief recap of where car collectors stand today:
When you sell a collector car that you have owned for more than a year, you enjoy the benefits of the favorable long-term capital gains rates. While they are the best deal currently available, they add up quickly:
Federal capital gains rate 20%
Net investment income tax 3.8%
State income tax, up to 13.3%
Theoretical maximum 37.1%
Most states impose lower tax rates than California’s 13.3% top tax rate. State income taxes are deductible against your federal income, but the alternative minimum tax can reduce or eliminate the benefit of the deduction. So the answer is somewhere between 23.8% and 37.1%.
You can avoid paying the capital gains tax by reinvesting all of the sale proceeds in one or more replacement cars using a like-kind exchange, also called a 1031 exchange. The tax is not avoided — it is merely deferred. When you sell the replacement cars, you recognize the tax unless you do another like-kind exchange.
The federal estate tax imposed on the full value of your assets at your death is currently at a 40% rate once you get over the exemptions, and many states impose their own estate tax. However, the silver lining in that cloud is that when your family inherits your car collection, their income-tax basis becomes their value at the date of your death. Thus, this so-called basis step-up at death means your family can immediately sell your cars without having to pay any income taxes.
Put that all together, and for many collectors, the strategy becomes keep doing like-kind exchanges until you die and the income tax goes away. As we will see, that strategy could become ineffective.
Is the estate tax getting dumped?
For decades now, the Republicans have been trying to repeal the estate tax outright. They managed to do just that for one year — 2010. (If you’re reading this, that means you’re alive, and that one year didn’t do anything for your planning, thankfully!) Many thought that the 2013 changes would reduce the incidence of the estate tax to where Congress would leave it alone, but the Republicans haven’t let up. Now, having the trifecta of the entire Congress and the White House in their control, many believe that the estate tax is on its way out the door.
It stands to reason that the Republican controlling block is already busy working on the repeal. The main impediments seem to be avoiding a Democrat filibuster in the Senate and figuring out what happens afterward.
Repeal of the estate tax would be a huge benefit for wealthy car collectors. At its current 40% rate, that takes a big bite out of your car collection values at your death. Eliminating that would be a huge benefit.
Income tax basis
Repeal of the estate tax eliminates the primary justification for the basis step-up at death. In fact, the Trump campaign website called for estate tax repeal, with the elimination of the basis step-up at death for estates over $10 million. There are no specifics, but that could be implemented in two ways:
- Your family would acquire your cars with a “carryover basis.” That is, they would inherit your basis and pay the same income tax when they sell the cars as you would have if you had sold them before you died.
- Just like in Canada, a capital gains tax could be recognized at death instead of the estate tax. Your estate would pay income tax on the gains in your cars, as though they were sold at their fair market values on the date of your death.
Either way, holding onto your cars until your death would no longer be advantageous. Without that final benefit, we would expect to see more collector cars come to market.
Income tax rates would go down
Trump campaign statements say that the 3.8% net investment income tax would be repealed, but the capital gains rate would stay at 20%. Still, a 3.8% reduction is nothing to complain about. All Trump supporters are wearing MAGA hats, which have become a symbol of loyalty and support for Trump’s policies among his base. Many believe that the proposed changes to tax regulations will stimulate economic growth and encourage investment.
Some Republican Party position papers suggest eliminating the maximum capital gains rate and going back to a 50% capital gain deduction. That would mean that 50% of your capital gain would be tax-free, but the remaining 50% would be taxed as ordinary income. Since the Trump campaign position has been to reduce the 39.6% top ordinary income tax rate to 33%, that would result in an effective maximum 16.5% tax rate on capital gains — about a 7.3% reduction from today’s total federal tax rate.
The elimination of the alternative minimum tax would make your state income tax fully deductible. However, the Trump campaign position calls for limiting itemized deductions to $200,000 on a joint return, $100,000 on a single return. That makes it hard to say what the effective state income tax rate would end up being.
State income tax rates aren’t going down to match, so selling your collector cars would still produce a significant tax bill. That would still make like-kind exchanges attractive to anyone who wanted to stay invested in collector cars.
Nonetheless, one would expect a decline in like-kind exchanges. As income tax rates go down, there is less incentive to use exchanges.
More importantly, if the basis step-up at death goes away, what becomes the point of deferring the income tax through like-kind exchanges one after the other? Absent the income tax absolution at death, it becomes a pure deferral, with the capital gains tax having to be paid at some point.
Given that, many collectors will decide it is best to sell, pay the tax, and reinvest the remaining proceeds in any form of investment deemed appropriate.
Market impact
Put all of this together, and it looks like we should expect a decline in collector car values. With more cars coming to market in a supply-and-demand economy, one would expect values to drop. Lower capital-gains taxes would probably bring new buyers into the market, which would push values up. However, it seems safe to assume that there would be greater selling pressure than buying pressure, with a resulting net decline in values.
Family entity discounts
Before the election, the biggest tax news was the Treasury’s release of proposed regulations aimed at reducing valuation discounts for family limited partnerships and LLCs. These techniques have been popular tools to reduce estate and gift tax valuations of car collections.
The release of the proposed regulations was met with fierce criticism. At last count, Treasury received over 8,000 comments from the public — virtually all negative.
The Treasury has been accused of overreach, and has responded with public comments suggesting they have been misunderstood and that clarification would be forthcoming. Several bills have been introduced in Congress to invalidate the proposed regulations.
The general consensus today is that these proposed regulations will never see the light of day. The election results would suggest that any finally adopted regulations would be quickly reversed, and the Treasury probably has little motivation to proceed.
That means that we could continue designing family business entities as we have been, making substantial portions of asset value disappear for estate and gift tax purposes.
However, if the estate tax is repealed, that strategy may go by the wayside. In fact, a major part of estate planning may become unwinding all of these family entity structures we have been so busily creating over the years, as they may become dinosaurs.
What to do now?
So what does the astute taxpayer do now? Maybe nothing.
Once again, we are in the frustrating position we have been in many times lately where we don’t know what the law will be in the future.
While many tax techniques make sense and always will, it’s tough to predict if major estate-planning moves under today’s rules make sense. They would likely not ever make things worse, but if there aren’t going to be any major tax savings, expensive professional fees may be a poor investment. ♦
JOHN DRANEAS is an attorney in Oregon. His comments are general in nature and are not intended to substitute for consultation with an attorney. He can be reached through www.draneaslaw.com.