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Last week I explained in theory how you
can legally avoid paying taxes on gifts and inheritances. Avoiding
taxes on gifts and inheritances is based on cost-basis. To help you
apply this to your situation, I want to share some real-life
examples of how my clients use these principles to legally avoid
paying taxes on gifts and inheritances.
First, let’s briefly review cost-basis. When you receive an asset as
a gift and sell it, you are responsible for paying capital gains
tax. Capital gains tax is calculated using cost-basis. Cost-basis
refers to how much money was invested in an asset. When an asset is
sold, the cost-basis is subtracted from the amount received to
determine the gain or loss. Your amount of gain or loss then
determines how much you will pay in capital gains tax. In other
words, you pay tax on the profit.
Cost-basis becomes complicated when an appreciated asset is passed
on to someone else, either through an outright gift or through an
estate. If an asset is passed on before the giver’s death, then the
recipient assumes the same cost-basis as the giver. If the asset is
passed on after the giver’s death, the recipient’s cost-basis is the
market value on the date used to calculate tax on the estate. This
‘stepped-up’ cost-basis can save tens of thousands of dollars in
capital gains tax.
A reader in St. Maries, Idaho was facing this very situation. A lady
has owned some utility stock for decades, happily collecting the
dividends. Now she’s getting older and wanted to give this stock to
her son. Little did she know this would have resulted in thousands
of dollars in unnecessary taxes!
If she had given these shares to her son, he would have a large
capital gains tax bill when he sold the shares. The way the IRS sees
it, his ‘profit’ wasn’t the gain since he received the gift; his
profit was based on how much his mother originally paid for the
shares. I explained that if the son inherited that stock after mom’s
death, they would legally avoid paying 15% in taxes on decades’
worth of gains. They quickly agreed!
The situation is far different for an elderly client of mine. He
lives on a farm that has been in his family for eight generations.
He inherited the farm over the 70 years ago and, obviously, it has
appreciated greatly. Since his estate will be over $1,500,000, his
family could lose up to 50% to estate taxes. Imagine -- his
daughters could be forced to sell the farm after 8 generations so
the tax could be paid!
In this situation, it is better to pay capital gains tax of 15% then
estate taxes of 50%. Plus, there isn’t any tax on the gains until
the farm is sold. Since his daughters plan on passing it on to their
children, the taxes can continue to be deferred for decades. So he’s
been carefully gifting the maximum amount he can to his daughters
each year over the last ten years. We calculated that he will
legally avoid $750,000 in estate taxes.
Few of us have large farms, but most retirees own their home. And
many times, the home is the most highly appreciated asset of the
entire estate. Unfortunately, as they get older many parents make
the mistake of putting their child’s name on the deed to their
house. This is an especially common practice for widows.
What people don’t realize is that when they put their child’s name
on the deed to their home, the IRS considers that a gift. Therefore,
the child has the same cost-basis as the parent. So when the child
goes to sell the house later, he or she will face a hefty capital
gains tax bill. If the value of the estate is less than $1,500,000,
there wouldn’t be any tax on the profit of the house if it was
passed through the estate at death.
So think twice before gifting someone an appreciated asset. Remember
that adding someone’s name to a bank or brokerage account is the
same as a gift. With some simple planning you can legally avoid
losing tens of thousands of dollars in taxes.
I’ll personally answer your financial questions. Go to
www.guardingyourwealth.com and click on ‘Ask Jeff’.
In addition to being a nationally syndicated columnist and Certified
Financial Planning Practitioner, Mr. Voudrie provides personal,
private money management services to clients nationwide. |
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