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How To Maximize the Tax Benefits of Estate Planning Gifts

Published on: Oct 30 2022
Estate Tax

Today’s high estate and gift tax exemptions could be slashed in a few years.

Maximize those and other benefits now.

The substantial increases in estate and gift taxes that were widely discussed in 2021 appear to be off the table, at least for now.

But the current lifetime estate and gift tax exemption is scheduled to be cut in half after 2025 if Congress doesn’t act to extend it before then.

In this article, I’ll discuss how to decide which assets to give loved ones to minimize not only estate and gift taxes but also income and capital gains taxes.

It is often better to give property than cash, especially investment property.

Recipients are less likely to sell property gifts to spend the proceeds, but they’re likely to spend cash gifts instead of investing them. If you’re giving to provide long-term benefits, give investment property instead of writing checks.

Property gifts carry tax characteristics and potential tax bills. To maximize the family’s after-tax wealth, focus on making gifts of the right property. Here are the key principles to follow, to maximize the tax benefits of your estate plan:

Don’t give investment property with paper losses.

In most cases, when you make a gift of property, the recipient takes the same tax basis in the property that you had. In other words, the appreciation that occurred during your holding period is taxed when the gift recipient sells the property.

But when the property didn’t appreciate while you held it, the beneficiary’s tax basis will be the lower of your basis and the current market value. So, when the investment lost value, the beneficiary reduced the basis to the current fair market value.

The loss incurred while you owned the property won’t be deductible by anyone. You can sell the property, deduct the loss on your income tax return, and give the after-tax proceeds. Or select other investment assets to give, as discussed in the rest of this article.

Give appreciated investment property after a price decline.

This strategy makes maximum use of the annual gift tax exclusion and minimizes use of your lifetime estate and gift tax exemption. You can give more shares of a stock or mutual fund by making the gift during a price decline.

For example, when shares of a mutual fund were at $60, you could give 266.67 shares tax free under the annual gift tax exclusion of $16,000. After the price declines to $50, however, you can give 320 shares without exceeding the exclusion limit.

When the recipient holds the shares and the price recovers, he or she will have received more long-term wealth without incurring estate and gift taxes or using part of your lifetime exemption. That’s why you shouldn’t focus on family gift giving only at the end of the year.

Determine early in the year the amount you want to give, and then look for a good time during the year to maximize the tax-free value of the gifts, such as after a decline in the markets.

Give property that’s likely to appreciate.

A primary goal of lifetime giving is to remove future appreciation from your estate and transfer it to your children or other loved ones.

This maximizes use of your lifetime estate and gift tax exemption and also minimizes your lifetime income, capital gains and estate and gift taxes. Giving property that will appreciate also maximizes the wealth of your loved ones.

So, when you have a choice, give loved ones property you believe will appreciate. This strategy is especially valuable when the beneficiary is in a lower tax bracket than you.

When the property eventually is sold, the beneficiary will pay capital gains taxes on the appreciation at a lower rate than you would have paid. You pass on more after-tax wealth and reduce the family’s taxes by carefully selecting the property to give.

Retain property that’s appreciated significantly. Sometimes giving highly appreciated property to a loved one is the smart move.

When it’s time to sell the property and the loved one is in the 0% capital gains tax bracket, it’s profitable to make a gift of the property and let him or her sell it.

Even if the loved one is in the 10% capital gains tax bracket, the gift can make sense when you’re in a higher capital gains tax bracket. But there are other considerations.

The gain could be significant enough to push the recipient into a higher capital gains tax bracket and a higher overall tax bracket, triggering higher taxes on all the person’s income.

More importantly, if there’s not an urgent need to sell the property, remember that you can ensure a 0% capital gains tax on the gains by holding the investment for the rest of your life.

When property is inherited, the beneficiaries increase the tax basis to the fair market value on the date the previous owner passed away. The beneficiaries can sell the property right away and owe no capital gains taxes. All the appreciation that occurred during your lifetime escapes capital gains taxes.

From a strictly tax-planning outlook, it’s better to hold for the rest of your life investments that already are big winners and have large capital gains. Make lifetime gifts of other property.

You won’t want to do this if the investment fundamentals indicate it is time to sell the asset, but otherwise it’s better to hold the highly appreciated asset for life and make gifts of other property.

Give assets that pay income.

The odds are you’re in a higher income-tax bracket than the people to whom you’re making gifts. Consider the different income tax brackets when deciding which assets to give.

When you hold investments that generate income each year and earn more income than is needed to cover your spending, consider giving some of those income-producing assets to others in the family who are in lower income-tax brackets.

That reduces taxes on the income, increasing the family’s after-tax wealth. In addition, the recipient is less likely to sell the asset to raise cash when it’s generating some income each year.

Remember that youngsters ages 19 or under (or under 24 if full-time college students) are subject to the Kiddie Tax, imposing their parents’ highest tax rate on investment income they earn above a certain amount, which is $2,300 in 2022.

At that point, gifts of income-producing property don’t produce tax benefits.

I often hear from parents and grandparents who are concerned that leaving their children a lot of money will ruin them. Annual gifts are a good way to see if that’s true and help the following generations get used to handling wealth.

Large inheritances usually ruin the heirs when they don’t have the knowledge to manage the wealth or aren’t mentally and/or emotionally prepared. Sudden wealth tends to cause problems. Lifetime gifts can reduce sudden-wealth syndrome.

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