When Gifting Is Not the Best Option

I often emphasize the important role gifting plays in estate planning, but gifting is not always the most effective way to minimize estate taxes. Since we are coming up on the end of the year, when gifting tends to increase because of the holidays and the need to get things done this tax year, I thought it would be good to go over some examples of when gifting is not the best option. 

Gifting Highly Appreciated Assets 

One of the most common mistakes I see clients make is gifting away assets that have significantly appreciated in value. In an effort to avoid probate, many parents will gift the family home or vacation property to loved ones. This can end up being a very expensive mistake because of the way our tax laws work. 

Most property is worth more than the yearly gift tax exemption, which is $14,000 per person for 2017 (or $28,000 per person if a couple is combining their gift tax exemptions). This means when property is gifted, the gift giver must pay a gift tax for any amount over the exemption level. 

If the property has appreciated in value since it was acquired, the gift recipient will also be hit with a capital gains tax on the property. 

For example, say your family has a cabin out by Shenandoah. When your family bought it back in the 1940s it was worth $50,000. Today it is worth $150,000. If this property is gifted to the next generation, the gift giver will have to pay a gift tax on $136,000. (The full value of $150,000 minus the $14,000 gift tax exemption.) The gift recipient will have to pay a capital gains tax on the difference between the original value ($50,000) and today’s value ($150,000), so $100,000. 

I have seen some families who had to sell the property that was gifted to afford the capital gains tax imposed. This is heartbreaking because with proper planning, the asset could still be in the family.

To avoid this mess, it can be a good idea to let highly appreciated assets pass through the estate at the time of death. When assets pass at the time of death, they automatically get a step up in basis, so the capital gains tax is avoided even though the estate tax is not. Advanced planning with trusts can also help families avoid the double gift tax plus capital gains tax whammy. 

Gifting Money for College 

The cost of college continues to sky-rocket, and many people want to help their young relatives cover some of the expenses. Unfortunately, the way a gift is given can significantly reduce other sources of educational aid. Sometimes it is actually better to let your loved ones go into debt, then help them pay it off after they have graduated.

When In Doubt, Ask

Gifting is such an important part of the estate planning process that its downsides are often downplayed. Just remember that the $14,000 exemption is not the only thing one needs to keep in mind when making gifting plans. If you have questions about a particular gift, don’t hesitate to speak with an attorney before letting your generous spirit run wild.

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