Suppose you own assets that you want to pass along to other family members. There’s an easy way you can do it.
Strategy: Make direct gifts to the family members. In other words, decide who should get what and then just simply give it to them.
Keep in mind that the basis of assets that you gift away can make a big tax difference.
Here’s the whole story: Under the annual gift tax exclusion, you can give gifts to each recipient up to a specified amount without any federal gift tax consequences. The exclusion amount, which is subject to indexing based on inflation, is $14,000 for 2014 (the same as it was in 2013). Therefore, you can give someone assets valued at up to $14,000 this year completely free of gift tax. You don’t even have to file a gift tax return.
The annual exclusion is doubled for joint gifts made by a married couple or when one spouse consents to a gift by the other. For instance, a couple could give a child or a grandchild up to $28,000 free of gift tax in 2014. However, in this case, you must file a gift tax return.
If the amount of a lifetime gift exceeds the annual gift tax exclusion, it is sheltered by the unified federal estate and gift tax exemption. For 2014, the exemption effectively shelters up to $5.34 million from tax. However, using the exemption for lifetime gifts erodes the tax shelter available for your estate.
Taxes should be a prime consideration in your gift-giving decisions. Significantly, the recipient generally carries over your tax basis in the gifted asset, except if the property has declined in value. In that case, the recipient is stuck with a basis equal to the lower of your basis or the fair market value of the assets on the date of the gift.
Follow these two rules of thumb for gifts to low-bracket family members:
- Give away low-basis property that is appreciating in value. When the property is sold, the gain will be taxed to the recipient in his or her low tax bracket.
- Keep high-basis property that is declining in value. If you give this property to a low-bracket family member, there will be a small loss, or no loss at all, because the recipient’s basis is the FMV. Any loss will be of limited tax value. However, if you keep the property and sell it yourself, you can claim a capital loss that can be used to offset capital gains plus up to $3,000 of ordinary income.
Example: You own stock with a basis of $25,000 that is now worth $15,000. If you give the stock to your granddaughter, her basis will be $15,000.
Alternatively, you can sell the stock yourself and realize a $10,000 capital loss. Then you can give your granddaughter $15,000 in cash. She’s basically in the same position as if you gave her the stock, but you’ve improved your tax situation.
Tip: Don’t let the “tax tail wag the dog,” but you should not ignore the tax bite either. Consider the economic implications.