Capital Gains Tax Planning: Gift versus Inheritance

Cary, NC Estate Planning Lawyer

Cary, NC Estate Planning Lawyer

When meeting with clients, a common question comes up: "Would it just be easier if we gave all of our _______ to our kids now instead of waiting until we die?" If you're a frequent reader of this blog, you know what my response is: "It depends." Here are a few factors and issues to consider before making the decision to gift assets. 

1. Are the Assets Highly Appreciated? 

If the parents in this scenario have a low cost basis in the assets - for instance, stocks they originally acquired in the 80's - there will be a significant capital gain tax for the kids if the shares are gifted and then sold. This is because the recipient of a gift will carry over the giver's cost basis. So, for example, if the shares were worth $50/share when they were acquired and are now worth $100/share, a gift of those shares to the kids would have the kids receiving them at the same cost basis as the parents: $50/share. So, if the kids went to sell them after receiving them, they would pay long-term capital gains tax on the $50/share in gain that was realized by the sale. That would be in the neighborhood of 28% tax. If the assets are not highly appreciated, the capital gains tax liability would be lower following a gift.

Passing the shares on via inheritance would allow the kids to receive a step-up in cost basis in the shares to the fair market value of the shares on the date they were received. This would eliminate the potential for capital gains tax if the shares are sold soon after receipt.  

2. Do the Assets Have Varying Costs Bases? 

Using the stock example again, most people accumulate stock over time and buy or receive them at different prices. This creates a situation where the owners have several different cost bases in the shares. Since gifting creates a carry-over cost basis, the kids would receive the shares in the same condition - with differing cost bases. This can be incredibly difficult for even financial professionals to determine how to calculate the capital gains tax in such a scenario.  

Passing the shares on via inheritance eliminates that issue by leveling the cost basis across all shares to the fair market value on the date of receipt, via the stepped-up cost basis rule I mentioned above.  

3. Are There Planning Advantages to Gifting the Assets? 

There may be advantages to gifting that far outweigh the potential tax detriment set out above. The primary advantage would be long-term care planning, which is means-tested and utilizes a five-year look-back for gifts made for the purpose of gaining Medicaid eligibility. If there are planning concerns such as these, the tax ramifications may be minuscule when considering the potential cost savings gained by qualifying for Medicaid long-term car assistance and North Carolina Special Assistance. 

Thorough and comprehensive planning is needed to evaluate all aspects of the gift versus inheritance dilemma.