To Gift or Not to Gift? Gifting Assets While You’re Alive
Often times, parents will decide they want to give assets away to a child while they are still alive rather than wait for the asset to be distributed to the child at death through a will or trust. There are of course several motivating factors for this decision. Regardless of the reasons, there are disadvantages and advantages to gifting assets that should be explored with an attorney prior to taking action. It is always easier to consult with an attorney before you take action, rather than to reverse a course of action after you have already made a gift.
Here are three disadvantages to gifting assets while you are still alive.
1. Step up in basis
A “Step Up In Basis” is probably the best and biggest tax break the IRS code allows. Normally, when you sell an asset that has appreciated in value, you pay what is known as a capital gains tax. But, for assets that are inherited, the IRS has a special rule, called the “step up /step down in basis.”
A step up in basis is the date of death value of an inherited asset used to calculate capital gains taxes when the asset is later sold.
So, why is it so important? Taxes. It saves your beneficiaries lots and lots of money that would otherwise be paid in taxes.
Ben is a beneficiary who inherited a house from his Dad when his Dad passed away in 2014. His Dad bought the house in 1997 for $400,000. At the time of Dad’s death (2014), the house was worth $1,000,000. The step up in basis rule allows Ben to receive a “step up” in the original cost basis from $400,000 to $1,000,000. If Ben decides to sell the property in 2015 for $1,200,000, Ben will only pay a capital gains tax on what he sold it for ($1,200,000) minus his stepped up cost basis ($1,000,000). So, Ben will pay capital gains taxes on his gains ($200,000). If there was no step up in basis, Ben would have to pay a capital gains tax on $800,000 (sales price of $1,200,000 minus the original cost basis of $400,000).
When a person gifts an asset during their lifetime, the person receiving the gift losses out on the opportunity to have this step up in basis.
Once an asset is gifted away to a loved one, the loved one’s creditors can come after the asset.
For example, Sally gifts a property to her daughter Sandy. Sandy gets into a car accident and is sued. She loses the lawsuit and the judgment creditor comes after Sandy’s assets, which now include the property Sally transferred.
3. Lack of control
When you gift away an asset to a loved one, you no longer have control over the asset. This is because you are no longer the legal owner.
Sally gifts her home to her daughter, Sandy. Sandy is the new owner on the title of the property. A few years later Sandy needs some money. So, she sells the property and kicks her mom out on the street. Sally has no legal recourse against Sandy because Sandy can do what she wants, she is the legal owner. (This extreme example illustrates the level of control that is being given up).
There are also other disadvantages to gifting assets, but these were just some of the major ones. There are also other consideration that play into this type of decision like property taxes, government benefits, gift taxes, etc. It is best to consult with an attorney before gifting property away to be sure that it is the right decision for you.