At some point in our lives, most of us expect to give or receive gifts or inheritances. The circumstances surrounding the gifts or inheritances may be positive or negative. But the income tax treatment is the same.
Income Taxation of Gifts and Inheritances.
Gifts and inheritances are not taxed as income when they are received, nor are they deductible for the donor. While the transfer may be subject to a gift or estate tax, generally this is not the recipient’s concern. The recipient need not report the gift or inheritance on his or her income tax return.
Income Tax Basis of Gifts.
What happens when the recipient turns around and sells the asset received? Here the treatment of gifts and inheritances is different. When you receive a gift, you also receive the donor’s income tax “basis.”
What is Income Tax Basis?
Generally, income tax basis is the price paid for the asset. The basis may reflect additional factors such as depreciation or the costs of acquisition. The concept of basis is important because it serves as the benchmark from which gain or loss is measured. If you sell an asset for $100 and your basis is $60, you have a $40 gain, whereas if your basis is $120, you have a $20 loss.
If the asset is cash, the basis is easy to determine, it’s simply the amount of cash. However, if the asset is the GE stock that your grandfather bought years ago, that is a different story. While it may be awkward, you need to ask the donor what his or her basis was in the asset. If the donor is uncertain, try to get as much information as possible so that you can figure it out for yourself. Note that for calculating losses only, the basis you get from the transferor cannot exceed the asset’s fair market value on the date of the gift.
Income Tax Basis of Inherited Assets.
If you inherited the asset, you do not generally inherit the old basis. Your basis is a “stepped-up” basis equal to the fair market value of the asset on the date of the transferor’s death. For a publicly traded stock, the new stepped-up basis is determined to be the average of the high and the low for that day. If on your grandfather’s date of death, GE had a high of $40 per share and a low of $38 per share, your basis would be $39 per share. Your basis is $39 even though your grandfather’s basis in the stock might have been $10. The executor of your grandfather’s estate can elect to use an “alternate valuation date,” which is six months after the date of death. In that case, if GE were then trading at $35 per share, your basis would be $35, not $39. One more exception: If you gave the donor the asset within one year of his or her death and you receive it back at the donor’s death, you do not get a new basis.
Now that you know the rules, how can you use them to your advantage? Gifts can be structured to help minimize income tax for the donor. For example, the donor can give appreciated property to someone in a lower income tax bracket, like a child age 14 or over (under age 14 unearned income is generally taxed at the parent’s rate). When the child sells the asset, the unrealized gain that occurred in the hands of the donor is taxed to the child at the child’s lower rate. This is an effective tool to lower the family’s overall income tax burden.
Planning to take advantage of the rules for income tax basis or transferred assets is a complex matter. A qualified estate planning attorney can help you and your family structure gifting to help minimize income taxes and estate & gift taxes.
Mr. Morrison is a board-certified estate planning attorney with experience in both simple and complex estate matters. He can prepare an estate plan for you that achieves your goals of passing your assets to whom you wish. The planning can even help minimize estate taxes. The firm has helped thousands of clients meet their estate planning goals and pass on lasting legacies to their loved ones. To learn more about how you can achieve your estate planning goals, please call (504) 831-2348 or visit our website at www.morrisonlawplc.com.
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