That is the question. As Christmas time approaches, seemingly fast every year, I wanted to discuss gifting. No, not the re-gifting you’re going to do with the fruitcake or massaging cell phone case. The gifting you do to transfer wealth to the next generation in a way that minimizes fees and most importantly, taxes.
There are essentially two types of gifts; intervivos and testamentary. Yes, that is Latin and yes, I’m trying to impress you. Simply, intervivos gifts are gifts made “during life” and testamentary gifts are those made “at death”. Let’s explore the basics of the two types and then get into the nitty-gritty.
Gifts during life are a common occurrence for most of us. We give our loved ones gifts for birthdays, milestones and holidays. Sometimes we give our loved ones (usually children) large gifts as a way to transfer wealth. Many people know the IRS’ gifting rules; you can only give away $14,000 per person per donor before you have to start paying gift tax. Yes, there is a tax on gifting money. In 2018, this amount increases to $15,000. So, what happens when you gift more than that?
When you make a gift during life of more than the amount allowed to pass tax free, you must file a 709, “United States Gift Tax Return” declaring the gift to the IRS and paying the tax (or showing a reduction in your lifetime gift allowance. This form also serves to report your “tax basis” for the purposes of calculating gain or loss in the future. Acciridng to IRS rules, the receiving party’s “tax basis” is the same as the “tax basis” from the person making the gift.
Let’s look at an example. You gift your home to your son. You originally purchased the home for $150,000. It is now worth $1,000,000. This is Sonoma after all! When you gift your home to your son, his “tax basis” is now your original $150,000. This means that if your son sells the house, he has deferred or built-in gain of $850,000. This would result in tax of approximately $250,000. Ouch.
What about “tax basis”? The rule says that if you receive a gift from someone because of the donor’s death (and not during the donor’s life) then the person receiving the gift’s “tax basis” is the fair market value at the donor’s date of death.
OK, it’ll clear what this means with this similar example: You gift your home to your son. You originally purchased the home for $150,000. It is now worth $1,000,000. When you die you leave your house (via a well thought out and comprehensive estate plan created by a competent estate planning attorney). Your son’s tax basis is the fair market value of $1,000,000. This means that if your son sells the house, he has NO deferred or built-in gain and there is NO tax to pay – compare this to the gift during life of the same house that yielded $250,000 in tax.
The simple lesson here is that gifting at death will likely result in favorable tax consequences to the recipient. If you want your kids to get more and the IRS less, create a gifting strategy that minimizes taxes and maximizes the benefits.
Please note that our current tax bill could change this but it is unlikely. Many of the issues they are discussing won’t affect the gifting rules but they could change the gifting amounts. Stay tuned!