Landowners, did you know that the rules for the Federal Estate Tax are scheduled to change dramatically on January 1, 2011? If your estate is valued at over $1 million and you have not met with an estate planner or tax professional this year, you might want to stop reading and make that phone call right now. It could be worth hundreds of thousands of dollars to your family at your death.

As things stand today, any assets in an estate valued at over $1 million would be subject to an estate tax or gift tax of 55% at the death of the owner. Simply put, the first $1 million will be exempt from the federal estate tax, and anything beyond that will be hit at this painfully high rate. This is because tax cuts made in 2001 by President Bush are phasing out due to inaction by Congress this year in extending or permanently changing the estate tax.

It does not take much imagination to see how this could affect large farmers or those with substantial timberland holdings, but smaller landowners in areas with high property values are also in danger of facing the estate tax as well. If you own a nice home, have a modest retirement account, and own some rural land, you are likely to be affected by the coming changes.

2010 is a year with 0% estate tax. This means if you pass away this year your estate is not subject to any federal estate tax. I have read in several articles that estate planners are speculating that some individuals will make decisions to suspend life-prolonging medical care such as chemotherapy or dialysis in order to try to save their families money at their passing. It is a shame that our tax code would be a consideration in the treatment of a medical condition.

The change in the code could easily mean that long-held properties must be divided and sold to pay the portion due to the IRS. If you calculate the 55% estate tax, a real estate brokerage fee, and closing costs necessary to close many transactions, heirs may be left with only 30% to 35% of their initial inheritance.

It is my understanding that there are options for protecting your estate such as trusts, limited liability corporations, and some types of family partnerships. You should consult an estate planner, attorney, or accountant for specifics on your particular situation. I am not a professional and do not offer any legal, accounting or other professional estate planning advice. My one suggestion would be to make that arrangement today. It is imprudent to believe that the tax laws will change, and you should act now based on the current guidelines. Your family will be grateful that you did.

It would be great for common sense to prevail in Congress, and allow our citizens who have worked hard to acquire means to leave to their heirs the unfettered right to do so. In the meantime, there is an ominous tax man staring you in the face. Contact an estate planner or accountant today.

The property tax generates a steadily declining share of local revenues according to a recent volume, Nancy Y. Augustine, et al., Erosion of the Property Tax Base: Trends, Causes, and Consequences (Lincoln Institute of Land Policy, 2009). The property-tax base is being narrowed by incentives and tax breaks that local governments provide to promote or protect specific public purposes, such as economic development, conservation, agriculture (land-use taxation), non-profits, religious activities and favored groups (e.g., homestead exemptions, senior citizens, veterans). The Lincoln Institute is a wonderful source of information on property taxes and other land issues.

Like many rural counties, mine – Highland County, Virginia — is overwhelmingly dependent on the property tax to fund its school system and other services. We don’t have a local sales tax or personal-income tax. Our business base is very small. Since almost all of the county is either agricultural land or woods, a land-use break for farmers and timberland owners would not work. We’d simply have to tax the same folks differently to raise needed tax revenues.

And like many rural counties, our budget is pummeled from every side–unfunded federal and state mandates, state budget cuts, lower school enrollment (which reduces the amount of state assistance), increases in the costs of services provided, taxpayer resistance to higher taxes, assessment values increasing periodically, and so on.

Two points, among dozens, can be offered on this complicated subject.

The federal government sent 1,850 local governments with federal land holdings in their jurisdictions about $381.65 million in FY 2009 in payments in lieu of taxes (PILTs). This was more than three times the FY 1999 total payment of $124.6 million.

Individual state payments, county-by-county, can be accessed at www.doi.gov/pilt/ for FYs 1999-2009. For illustration, Virginia’s average PILT payment per acre in FY 2009 was $1.86; Mississippi’s $.90; California’s $.79.

Twenty percent (54,526 acres) of Highland’s 266,240 acres is federally owned. We received $91,526 in PILT payment in FY 2009, or about $1.68/acre. Undeveloped private land is taxed at $8/acre and up, agricultural land higher than woods. At a minimum, Highland loses more than $6/acre over the PILT payment in annual property tax revenue for each acre of federal land every year.

Every county that receives PILT money has to make up in some way this loss. Private property owners must pay higher property taxes to offset the lost revenue from federal lands. While PILT payments have increased per acre over the years, the underpayment compared with private property payments continues to burden real-estate owners in rural counties.

The PILT formula should be adjusted to better compensate counties for federal land ownership—something like 100 percent of the average per-acre tax levied on privately owned property of each land type.

A second area where the property-tax base has been narrowed is on land that has been encumbered with a conservation easement. My back-of-the-envelope guess is that more than 10 million privately owned acres are currently enrolled with land trusts, national land conservation organizations or public agencies. (A fair amount of Googling did not turn up a current total.)

Federal tax policy provides generous benefits to private landowners who donate a right of use on their properties for conservation purposes. (See Trust for Public Land, The Conservation Easement Handbook, Chapter 6 and IRC Section 170 [h] and IRS Treasury Regulations Section 1.170 A-14.)

Once the landowner has given away a valuable right in his property to the easement-holding organization, his property is now worth less than it was. And its tax-assessed value should be lowered to reflect the loss of market value. This means, of course, that the county loses property-tax revenue. The easement-holding organization doesn’t pay property tax on the right it now owns, because it’s either a non-profit or a public agency.

If, in other words, an owner severed the right to develop his property or sell its timber commercially, its market value might be reduced by half or more. Thus, the tax-assessed value could be reduced by that percentage as well and property tax revenue from that land will be lowered in perpetuity to reflect the subtraction of the donated right.

My feeling is that the federal tax benefits (and state benefits where applicable) are sufficient to reward landowners who want to use a conservation easement.

Some counties can afford the loss of tax revenue that results, and others can’t. If all property were in conservation easements, then the property-tax rates would be raised on all property owners to generate needed revenue. Since all property is not in easements (and can’t be), the burden of the tax loss is shifted to other revenue sources, usually other real-estate owners who have not or cannot use such easements.

My guess is that most jurisdictions can’t maintain valuations on conservation property at the pre-easement level. Therefore, I think that those who donate those rights should consider voluntarily paying property tax on the basis of what would have been levied in the absence of the easement, depending on the needs of the particular county.

I’m not sure reliable answers are available. Campaign promises are preferences, not contractual obligations. Circumstances — the economy, control of Congress, competing demands — will shape what either wants to do as President as well as what is feasible. But mostly neither has said.

On fiscal policy, they share some positions. Both appear to like balanced budgets, pay as you go and deficit reduction, but both have proposed policy packages that would increase the national debt—McCain more than Obama.

Both urge tax cuts and spending as part of a post-election stimulus package now being worked up in Washington, but with different components and orientations.

McCain now supports continuing the Bush tax cuts that he opposed when they were enacted. Obama supports tax cuts for the majority of taxpayers and tax increases for the top five percent.

The tax positions that both candidates have taken in their stump speeches differ from the positions their campaign staffs and economic advisers advance.

Obama’s stump-speech position indicates a policy that would generate an increase in after-tax income in 2009 for the bottom four quintiles, something less than six percent for the lowest 20 percent to something less than two percent for the fourth quintile. The top quintile in Obama’s stump speech shows a drop in after-tax income of more than two percent. His stump-speech policies would lower after-tax income for the top one percent by about 9 percent and the top 0.10 percent by about 11 percent.

Obama’s staff and advisers, however, say that his policies will raise after-tax income for every quintile, from a little more than six percent at the bottom to about two percent for the top quintile. Their positions show a drop in after-tax income of about one percent for the top one percent and about three percent for the top 0.10 percent.

McCain’s stump speech also differs from his staff positions.

McCain’s speech shows all quintiles gaining in after-tax income, from less than one percent in the bottom quintile to six percent in the top quintile. His stump speech shows the top one percent would gain more than eight percent after tax and the top 0.10 percent would gain almost ten percent after tax.

His staff position follows the same trend, but it shows a larger increase in after-tax income in all quintiles than his stump speech, with the top one percent getting an almost ten percent gain and the top 0.10 percent almost 12 percent.

These positions are compared in detail at www.taxpolicycenter.org. The non-partisan Tax Policy Center finds that both tax plans would substantially increase the national debt over the next ten years—McCain by $5 trillion, Obama by $3.5 trillion. McCain would reduce taxes by nearly $4.2 trillion, and Obama by $2.9 trillion. While each spreads the tax burden differently, the general ideas of McCain and Obama would raise about the same amount of revenue.

Politicians change some of their positions over time as circumstances change. That’s not flip-flopping, saying one thing here and another there. It’s adapting.

Comparing the tax positions of McCain and Obama is somewhat unfair to McCain because he’s been voting on national tax policy six times longer than Obama—in economic conditions that have changed significantly.

McCain opposed President Bush’s $1.35 trillion tax cut in 2001, one of two Senate Republicans to do so. He said at the time: “I can’t in good conscience support a tax cut in which so many of the benefits go to the most fortunate among us at the expense of middle-class Americans who most need tax relief.” McCain also opposed the $350 billion Bush tax cuts in 2003. For those positions, Grover Norquist, the conservative anti-tax advocate, called McCain a “tax-increasing Bolshevik.”

In the 2008 campaign, McCain advocates making both Bush tax cuts permanent and proposes additional cuts. Norquist now endorses McCain.

In the third debate with Obama, McCain said: “So let’s not raise anybody’s taxes, my friends, and make it be very clear to you I am not in favor of tax cuts for the wealthy.” Both McCain’s stump speech and advisers advocate tax cuts for everybody, including the wealthy.

McCain supported the recent $700 billion Wall Street rescue, as did Obama, but McCain’s position this spring was that “it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers.” (George F. Will, “McCain’s Housing Restraint,” Washington Post, April 6, 2008.) Of the two, Obama has been more consistent on taxes and spending over the last year or so.

Tax breaks benefit some groups at the expense of others who make up the difference.

The Congressional Joint Committee on Taxation in September, 2007 projected the cost of “federal tax expenditures” (tax breaks) for fiscal years 2007-2011.

The Big Three homeowner breaks are: 1) the deduction for mortgage interest on an owner-occupied residence was projected to cost $79.9 billion in 2008; 2) the deduction for property taxes on owner-occupied residences, $14.3 billion; and 3) exclusion of capital gains on the sale of owner-occupied residences, $29.0 billion. (http://www.house.gov/jct/s-3-07.pdf.)

Together, The Big Three came to an estimated $119 billion in 2007, and the Joint Committee projected them to grow to about $164 billion in 2011. McCain said that the “mortgage interest deduction should be left alone; it’s embedded in the U.S. tax code.” (Realtor Magazine, September, 2008, http://www.realtor.org.)

Both candidates appear to favor keeping all three “as is,” though information is sparse on the deductibility of property tax and the capital-gains exclusion.

The Big Three only benefit those who itemize deductions. Itemization increases significantly as income rises. McCain is against a mortgage tax credit for families who don’t itemize. Obama favors a ten percent “universal” mortgage credit for non-itemizers.

These deductions help many Americans. Bruce Hahn, President of the American Homeowners Grassroots Alliance, told me: “The mortgage-interest and real-estate tax deductions and the home-sale capital-gains exclusion encourage home ownership, which contribute to social stability and the accumulation of home equity, the biggest source of retirement savings for most Americans. Existing ceilings…and other limitations…

prevent these worthy deductions from disproportionately benefiting the rich.”

Critics argue The Big Three are regressive, inequitable, inefficient and expensive. William G. Gale, et al., “Encouraging Homeownership Through the Tax Code,” Tax Notes, June 18, 2007. (http://www.urban.org/UploadedPDF/10001084_Encouraging_Homeownership.pdf.)

Here are some property-related tax issues for comparison.

Capital-gains rates. McCain wants to keep “as is” current long-term, capital-gains rates, with a top hit of 15 percent. But as part of his stimulus package, he proposed last week to cut this top rate to 7.5 percent for 2009-2010, at cost of about $10 billion. (http://money.cnn.com/2008/10/15/news/economy/capital_gains?postversion=2008101516) The Tax Policy Center estimates that two-thirds of the benefit of halving the top capital-gains rate will go to those making $1 million or more in 2009; those making less than $50,000 would likely get nothing.

Obama wants to retain current capital-gains rates for families with incomes below $250,000 and increase the top rate to 20 percent for the top two income brackets. That would be 20 percent for a couple making more than $250,000 and a single filer with more than $200,000. He favors requiring information reporting of tax basis for gains.

In current circumstances, both candidates might consider tax changes on losses as well as gains.

Estate tax. McCain wants to make permanent a $5-million- per-individual, $10-million exemption per couple with a 15-percent top rate on estates exceeding that amount. Obama wants to cap the exemption at $3.5 million per individual, $7 million per couple with a 45-percent top rate—the 2009 rules. Both favor “portability,” which essentially doubles the exemption amount for the surviving spouse.

Most estates would escape federal taxation under either policy, as they do now. Tax-planning tools are available to protect estates that exceed the exemption, in whole or part depending on their size.

Neither candidate favors either reversion to the pre-2001 rules in 2011 or full repeal, which would cost about $522 billion in lost federal revenue over the next ten years.

Farm aid. McCain opposed the 2008 farm bill; Obama supported it. McCain described it as “a $300 billion, bloated, pork-laden bill” and opposed ethanol subsidies. Obama supported this subsidy. (Candidate answers to American Farm Bureau questions are at www.fb.org, FB News, September 22, 2008, “Election 2008.”) McCain has said: “I don’t support agricultural subsidies no matter where they are.”

Neither campaign responded to inquiries. So voters might ask: Would you continue present tax policies or change them –and, if so, how — on the following:

• deductibility of mortgage interest on second home
• deductibility of property taxes
• capital-gains exclusion on the sale of owner-occupied residence; second home
• residency requirement to qualify for capital-gains exclusion on residence
• reduce the holding period required to qualify for capital-gains treatment
• 1031 exchange rules
• deductibility of donated conservation-easement value
• second-home rules—personal use, deductions
• hobby-farm rules
• taxability of various agricultural/conservation, cost-share programs
• farm taxes–expensing and depreciation rules for farm/land equipment and improvements, among many other issues
• increasing the number of tax brackets to promote fairness and compliance
• timber taxation for small landowners
• treatment of rental income
• expensing and depreciation schedules
• self-employment and home-office rules
• passive-activity loss rules and carry-over loss rules

Tax rules and policies like these are the realm of “special interests,” which both McCain and Obama deplore. Each American, of course, is a bundle of special interests, even Joe, the Plumber.

Presidents define where a special interest intersects with the public interest. If the candidates believe that both individuals and society benefit from widespread property ownership, then policies and tax rules can be established that encourage it. Tax policies can make it easier or harder to buy, maintain, hold, sell and profit from property.

My little excursion into these dark, swirling waters left me wondering which direction each candidate would row…and whether they would use one oar or two.

When you buy real estate, you will often need to allocate basis at the time of purchase among several different accounts, such as improvements (house, barns), timber (separate merchantable timber with immediate sale value from pre-merchantable with future value), minerals and land. The total of these basis accounts cannot exceed your overall basis in the property. Individual basis accounts are set up at the time of purchase, because a landowner often does different things in each account, which increase or decrease the individual account’s basis. As you hold the property, each basis account will be adjusted according to what you do. If you build a bridge, the basis in your land account increases, because it is a permanent improvement in the property. If you sell an acre from your land account, your basis will be reduced. Separate basis accounts can help you pay off a purchase through the sale of some assets.

All this jiggering of basis accounts is important to a landowner for tax purposes. Adjusted gross basis is the figure used in determining your tax liability when you sell or when the property is inherited. Each basis account will have its own adjusted gross basis at any particular point in time.  Sale of a house from a land acquisition, for example, just after you purchase the property will in all likelihood use up all the basis in your house-basis account.  The amount of tax you owe on the sale of a particular asset is determined by the amount of taxable gain you have. Taxable gain is the difference between your net selling price and your adjusted gross basis in the house. If you sell the house you just bought for what you just paid for it, you will have no taxable gain in the house basis account, hence no income tax on that sale. If you sell the house for more than what you just paid, you calculate your taxable gain, then pay your ordinary income rate on the gain. If you use up all the basis in your house account, your overall adjusted basis in the property as a whole decreases.

People who inherit property get, for tax purposes, a basis that is stepped up to its current market value, not the original basis. If they got the original basis, they would usually have a very large taxable gain when they — the heirs — sold the asset. With a stepped-up basis, taxable gain is figured on the adjusted basis at the time of death and inheritance. This increases basis and decreases taxable gain upon sale.

Steve Metcalf of Metcalf Land told me about a situation where the wife and kids of a deceased husband needed money that was locked up in appreciated land value. They want to sell some of the land to finance assisted care.  The widow’s adjusted basis in the land is about $1,000/A and the land’s current value is about $15,000/A.  This would produce a taxable gain of about $14,000/A. Taxed at a capital-gains rate of 15%, these circumstances would produce a tax hit of $2,100 on every acre.

If tax policy were changed to allow for the widow to transfer the land to be sold to her kids before she dies at the stepped-up value, they could sell it and avoid the big tax hit. As it is, they can’t afford to finance her care without the sale of the land, and the sale of the land by the widow will significantly reduce the amount of income available for her care.

So what is wrong with changing the tax code to allow for stepped up basis to heirs prior to the death of the Mom? The heirs, after all,  will get the stepped up basis when she dies.

Those who want to keep up with federal tax policy might start with Mark A. Segal’s, Real Estate Practitioner’s Tax Guide, current edition, from Knowles at www.knowlespublishing.com.

Are there any ways available for the family to sell some of the land for Mom’s long-term care and avoid the tax hit? What are your thoughts?

Tax policy is often used by the government to discourage and encourage certain behaviors. How each of us defines the best interest of the country determines what our tax-policy preferences are.

But as a general exercise in seeing what we think, what are your opinions on the following “land issues,” as they relate to tax policies:

1.  Capital gains rate for small (say under $2 million) land investments? Lower, higher, same?

2.  Capital gains rate for large land investments? Lower, higher, same?

3.  Do more, less, or same to help second-home ownership?

4.  More generous, less generous, or same federal tax benefits for conservation-easement donation?

5.  Make it easier for individuals to put retirement savings into land through an IRA and other vehicles?

6.  Should certain types of land improvements be expensed rather than depreciated? Is there a public benefit to that position?

7.  Should the dealer tax policy be relaxed, stay the same, or tightened?

8.  Should division be encouraged, discouraged, or left alone? What types of division?

9.  Should 1031 rules be changed to allow/promote deliberate sequential exchanges?

10. Is there a public interest in promoting small-farm ownership and production that would justify tax incentives for such owners and their production?

11. With the backout of timbering on public lands, should tax incentives be offered to private landowners to mangage woods for timber production and provide a break on timber-derived taxable gain?

12. Should building and use restrictions on floodplain, critical habitat (for endangered species) and wetlands be considered a taking and therefore made eligible for tax assistance?

Other ideas? For and against.