For those lucky enough to make it to our 70s, 80s, and beyond, gifting property is one of the greatest pleasures one can have. Everyone wants to see how their own hard work during their lifetime makes the journey easier for those closest to them. Setting up a nephew’s first brokerage account or gifting your newlywed granddaughter her first home feels good.
Yet those blessings might become a curse if one is not aware of the tax consequences. This article will briefly explain why gifting property during one’s lifetime may do a disservice to those beneficiaries. Please note this article is intended for educational purposes and is not legal advice.
Tax Concept: Basis & Gain
When it comes to property, tax is assessed during a “taxable event.” For this article, the focus will be on the sale of property. When property is sold, tax is assessed and due on the sale.
To determine how much tax is owed, two pieces of information are needed: the property’s basis and the sale amount. A property’s basis is the amount initially paid for the property. When property is gifted, the recipient retains the gift-giver’s basis; this is known as carryover basis.
Once property is sold, the difference between the sale price and the basis is considered gain. The Internal Revenue Service taxes gain. The tax rate and type of tax will depend on the owner’s income level, how long the property was owned, and various other variables that are beyond the scope of this article. The important takeaway is that a property’s basis is vital to calculating tax.
Stepped-Up Basis: The Greatest Tax Loophole
One of the easiest of minimizing the tax burden on property is for it to pass to others at your death. When property is owned at death and passes to another, the basis changes from whatever it was initially to the fair market value (FMV) at the time of the owner’s death. There is no limit on how high a stepped-up basis can become. For this reason, millions of dollars’ worth of tax can be avoided ensuring property passes at death.
To illustrate, imagine Mom buys a house for $10,000 in 1970; this is her basis. After fifty years, Mom’s house is now valued at $1,000,000. If she gifted her home to Son before passing away, that basis carries over to Son. If he sold the house at its current value, he would owe tax on the $990,000 ($1,000,000 minus the basis of $10,000) disregarding any other applicable tax laws, exemptions, or the like.
If Mom had instead devised the home to Son through her last will & testament, the home’s new basis would the fair market value of $1,000,000. If Son sold the house for this amount, he would owe ZERO in tax because there was no gain within the meaning of the Internal Revenue Code.
Gifted Property & the Tax Burden
For these reasons, it may actually harm your intended beneficiaries to gift property during one’s lifetime; surprise tax bills can destroy a family’s finances. Several forms of property benefit from the stepped-up basis rules and so care should be taken to ensure that the tax consequences of one’s gifts during life do not cause problems.
Are you considering giving your loved ones gifting during your lifetime in anticipation of passing away? If so, I would be glad to advise you on the consequences, tax-related and otherwise, before you do so. Please feel free to reach out via phone at 903-221-9180, our Contact Us form, or my email address at matt@matthewlewislaw.com.
Note: This article was not written with any particular state law in mind. It is generalized information intended to be used exclusively for educational purposes. This is not legal advice, and no attorney-client relationship has been formed between the reader and the Law Office of Matthew C. Lewis.
