A Gift to your Children may Raise their Tax Bill

By Libby Banks, The Law Office of Libby Banks

Lifetime gifts may cost your children dearly in capital gains taxes. It all revolves around something called income tax basis. While income tax basis may not be the most exciting topic, it is very important. Simply put, what you don’t know about income tax basis could end up costing you or your family dearly in capital gains taxes. When we do estate planning we consider tax basis. It’s one way we keep your hard-earned money in your and your heirs’ wallets.

What is Basis and Why Should I Care?

Basis, from an income tax perspective, refers to the cost you paid for an asset, plus any amount you paid to improve the asset, less any deductions you’ve taken against the asset. Your basis is used to determine the amount of capital gain or loss to report on your income tax return when the asset is sold. For instance, if you bought an asset for $100,000 and sold it for $300,000, you pay capital gains tax on the difference — $200,000.

In the estate planning world, there are ways we can get what is called a “step up” in basis for our heirs. But many people doing planning ignore basis and end up eliminating the step up in basis, unnecessarily costing their heirs in taxes.

 Lifetime Gifts: A Basis Disaster Waiting to Happen

From an estate planning perspective, a basis is a factor you must always consider when you’re thinking about making lifetime gifts. For example, if you decide to gift to your daughter that low basis AT&T stock or a lake house that has been in the family for years, then that gifted property will retain its low basis in your daughter’s hands. In other words, your basis is transferred to your daughter and becomes her basis. Unfortunately, this also means that there will likely be significant capital gains when your daughter sells the property you gifted to her. Going back to our example, a gift during your life means your daughter has a basis of $100,000 and when she sells for $300,000, she too will pay capital gains on $200,000.

If, on the other hand, your daughter inherits the property from you, she will get a “step up” in basis to its fair market value as of the date of your death. Thus, if she sells the inherited property shortly after your death instead of holding on to it for years into the future, she is likely to pay little or no capital gains taxes.

 
Putting Your Asset in Joint Ownership With a Child Eliminates the Step Up in Basis

(Note: This DOES NOT apply to own assets in joint tenancy with a spouse!) I see many clients put their assets in joint ownership with their children. Sometimes this is a homemade probate avoidance plan. And while it might avoid probate, it will probably cost far more than the probate fees (or the fee for a good estate plan) in capital gains taxes.

By putting your home or stock account in joint ownership, you are giving a lifetime gift that eliminates any step up in basis at your death. Because you gave a lifetime gift, the child or spouse added to the title now has the same low income tax basis that you do, and will pay the capital gains taxes when it is sold.

 
The Bottom Line on Basis

To avoid a basis disaster, if you’re considering gifting that low basis stock or house to your children or other beneficiaries, please contact us before you do. Basis remains a critical factor in any estate plan. Failing to update one’s estate plan or ignoring a low-cost basis when a property is gifted or sold can lead to disastrous tax consequences. So before you gift or sell that Google, Amazon, or Microsoft stock you bought years ago, give us a call. We are here to answer all your questions. You can reach us at 602-375-6752, or Libby@libbybanks.com.