Warning: Before Gifting Assets to Your Adult Children, Be Aware of Capital Gains Tax Consequences

I was recently speaking with a wonderful couple following one of our live educational events and one of their many questions was that they were considering ways to reduce their estate during their lifetime. This couple wanted to start giving away their wealth to their adult children. Specifically, they wanted to give a vacation property to one adult son and wanted to give two investment rental properties to the other adult daughter. I explained to this couple that they should come into the office and discuss this ever before they make any decision about gifting their assets to their children during their lifetime.

Whenever you give away assets during your lifetime, there are two potential tax consequences that can be implicated. The first is the Federal Estate and Gift Tax and the second is the Capital Gains tax. Under the Federal Estate and Gift Tax, the IRS can tax the amount of assets that you hold over and above $5.4 million that you pass at death. If you have more than $5.4 million in your name at your death, then the IRS can tax the overage at a top tax rate of 40%. As you can see, approximately less than 1% of Tennessee families have the Federal Estate and Gift Tax to worry about.

However, the Federal Estate and Gift Tax also says that you can give away up to $14,000 of individual assets or $28,000 of jointly held assets with a spouse to anyone you want each year without any gift tax consequences. If you give away more than that amount in a year then your $5.4 million exemption is reduced by that overage.

For example, let’s say that John and Jane gave away $50,000 to Jimmy to go to college. In the eyes of the IRS, John and Jane made a $22,000 taxable gift. Therefore, instead of having $5.4 million exempt from the federal estate tax at death, they only have $5.378 million exempt from the federal estate tax.

You also need to be aware that gifting away assets during your lifetime can come with some consequences for that person receiving the gift as well. For instance, there are three concepts when it comes to understanding taxes. These concepts include tax basis, carry over basis, and step up in basis. A tax basis is the value that the IRS uses to calculate the tax that you owe when you sell a specific asset. When you purchase an asset, the value of that asset on the date of your purchase is usually the tax basis for the IRS determining your tax basis. When you sell that asset, a capital gains tax will be assessed by the IRS.

For example, let’s say that John and Jane purchased 10 shares of Microsoft Stock at $100 per share in 1980. Let’s say that 20 years later they sell the stock in 2000 at $500 per share. John and Jane have made a $4,000 profit on their investment, the difference between the $1,000 they paid for the 10 shares as opposed to the $5,000 that they sold the 10 shares for 20 years later.

However, if you give away an asset to someone during your lifetime, the IRS considers the new owner to have a carryover basis. This means that the person who was gifted the asset, that person has the same tax basis as you did when you bought the asset. Therefore, if we use the John and Jane example, if instead of selling the 10 shares of Microsoft in 2000 they gave away the 10 shares to their son, then their son would owe a capital gains tax on the $4,000 gain if he turned around and sold the 10 shares.

The situation is different if instead of giving away the asset, the asset passes to a loved one at death. If this occurs, then there is a step-up in tax basis. For example, let’s say that John and Jane passed away and the 10 shares of Microsoft passed according to their trust to their adult son. Instead of having a $100 tax basis, he would have a $500 tax basis. There is a step-up in tax basis and the tax basis is the tax basis on the date that John and Jane’s son inherited the 10 shares in Microsoft. Therefore, if he immediately turned around and sold the 10 shares, there would be $0 capital gain tax liability.

As you can see, there are significant tax consequences for all those involved when it comes to giving away assets during your lifetime and at death.

If you have questions about estate planning in Tennessee, establishing a revocable living trust or an irrevocable Medicaid trust, avoiding nursing home poverty and Medicaid planning, or any other estate planning topics, then I encourage you to attend one of our free live educational events scheduled this month. At these events, you will hear a lot of real life stories about families that paid thousands of dollars in unnecessary expenses, families that were able to avoid unnecessary expenses, and families that were able to protect their assets from unnecessary nursing home costs and expenses.

I look forward to speaking with you at one of our upcoming live educational events!

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