Lifetime Gift or Bequest on Death? Basis Related Tax Consequences

by Ryan Duffy

When passing property to their loved ones, grantors should consider a myriad of factors, both financial and non-financial.  Various non-financial factors should not be discounted in determining when to give gifts, such as the joy in watching the use of the gift and the financial savvy of donors, but as in many financial decisions, tax considerations may provide extra guidance.  Tax basis in gift property should be considered in determining whether a gift should be made during the grantor's lifetime or upon death.  Tax basis, in a simplified world, is the price at which the grantor acquired the property (with various adjustments for depreciation, gain, loss, etc.).  The basis rules under IRC Sec. 1014 must be paid close attention.

Under current rules, a beneficiary would receive "carryover basis" in a gift from a donor.  In other words, generally the beneficiary would have the same basis in the property as the donor had immediately prior to transfer.  In contrast, if a beneficiary receives property as a result of the death of a grantor, the beneficiary generally receives a "step-up" in basis to the fair market value of the property.  This means, regardless of the decedent's basis, the beneficiary's basis in the property is fair market value at date of death.

By way of example, Bill Donor has a ranch that he purchased in the 1960s for $75,000.00.  Mr. Donor’s ranch has significantly appreciated in value due to a myriad of factors, including urban development nearby and the prospect of retooling the land.  The ranch is now valued at $400,000.00.  If Mr. Donor gifts the property to his daughter, Ms. Jane Donor, she would have a basis in the gift of $75,000.00, with a built-in capital gain (taxed at 15%+) of $325,000, which must be paid if ever sold.  In contrast, if Mr. Donor allowed Jane to receive the property on his death, her basis would be the fair market value at such time, eliminating the built-in capital gain.

As one can imagine, transferring property without careful consideration of basis may have severe adverse consequences.  A simple mistake such as transfer of property with significant appreciation during the donor’s lifetime could result in the beneficiary paying quite unnecessary capital gain taxes.  Notwithstanding, capital gains are typically at a lower rate than estate or gift taxes, hence the necessity to evaluate the overall economic effect of both aspects.  Lifetime gifting of property, even considering the basis rules, may make great sense as a tool to “freeze” the estate value, and effectively push any subsequent estate appreciation to the donee.  In short, it pays to carefully consider the benefits and consequences, financial and non-financial, in your choice of how to pass property to the next generation.

For more information regarding how to pass property, contact Ryan Duffy at 272-9241 or rjduffy@andrewsdavis.com. Read more about Ryan here.


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