Whenever we are involved in an estate plan, several questions arise. Should I gift assets to my heirs during my lifetime, or should I hold them until death? Which assets should I focus on?
Under tax reform, the lifetime estate/gift tax exclusion doubled to the current $11.4 million per individual. This gives a married couple the ability to exempt $22.8 million of assets from estate or gift tax. As a result, a significant number of estates will no longer be subject to the federal estate tax. The answer to these questions has created a planning shift for estates that fall within these exclusions. That shift has gone from estate planning to income tax planning.
Tax reform retained a provision that provides for a “step-up” in basis upon death. This enables individuals to escape the payment of capital gains tax if an appreciated asset is sold. For example, suppose one of your parents is still alive and the total value of their estate is $5 million. The value is well under the individual exemption of $11.4 million, and if they died today there would be no estate tax.
Let’s assume they own a property that has a cost basis of $200,000 and has appreciated to a fair market value of $1 million. If your parent gifts the property to you, there would be no gift tax and you would receive the property and assume your parent’s cost basis of $200,000. If you subsequently sold the property for $1 million, you would have a taxable $800,000 capital gain and you would pay a federal income tax of approximately $160,000. However, if your parent held the property at death, as their heir, you would receive the property with a stepped-up basis of its $1 million date of death fair market value. If you immediately turned around and sold the property for $1 million, you would have no taxable gain for income tax purposes. The appreciated value not only escapes the estate tax, but also the income tax.
This is a significant benefit for estates that fall under the estate tax exclusions. If you are considering making gifts, you need to carefully select which assets to gift. During your lifetime, consider gifting cash or assets with little appreciation and holding assets until death that have highly appreciated.
The basis step up at death applies to all estates including those that exceed the exemption amounts. Planning for estate taxes and income taxes is a complicated matter. Absent a law change, the exemption amounts mentioned above are scheduled to be cut in half in the year 2026. Life expectancy, long term care, Medicaid, and many other factors need to be considered in making planning decisions. It is critical that you consult with a qualified tax professional.
Richard J. Nelson can be reached at Email or 215.441.4600.
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