What Is Selecting Property to Give?
Not surprisingly, this explains the process of choosing a particular piece of your property that you want to give away. Selecting the property is a final and yet most difficult decision you'll need to make when you have decided that lifetime giving is an estate planning strategy that is right for you.
You're ready to make this final decision after completing the following process: (1) you found out what a gift is for tax purposes and how a gift is taxed, (2) you considered all the nontax and tax advantages of making lifetime gifts instead of transfers at death, (3) you determined that lifetime gifting is appropriate for you and you formed your particular gifting objectives, and (4) you decided how to make the gift, to whom to give the gift, and when to make the gift. Now, finally, you must decide what the best property to give is.
What Property Should You Give?
You should select property that will attain both your personal objectives and tax-saving objectives to the greatest extent possible. However, if a particular selection meets one objective at the expense of the other, you'll have to make the choice that is best for you.
Property That Will Give Your Personal Satisfaction
You may have particular pieces of property that you want to pass on to a particular person for sentimental reasons. For example, a mother may want her oldest daughter to have her grandmother's wedding ring, or a father may want his youngest son to have the race car they've both been working on over the years. This type of selection will come easily from your heart, not your head, so give and enjoy.
Property Expected to Appreciate
For tax-savings purposes, the most advantageous type of gift you can make is of property that is likely to grow substantially in value over time, such as life insurance, common stock, antiques, art, and real estate. This strategy removes the future appreciation of this property from your estate. You make the gift when tax values are lowest. The result is that you may either pay less taxes or use less of your applicable exclusion amount.
Example(s): Hal starts a small department store in his hometown. After a few fairly successful years, Hal transfers 90 percent of his interest in the growing company among several family members and forms a family partnership. He makes use of the annual gift tax exclusion, the unlimited marital deduction, and his applicable exclusion amount to reduce his taxable gifts to a minimum amount. Hal pays a small amount of gift taxes on the property transfers. Forty years later, Hal has opened hundreds of new stores and the family partnership is a highly successful, nationwide business worth billions of dollars. Hal dies. Only the value of his 10 percent interest (the interest he retained 40 years ago) in the billion-dollar business is included in his estate for tax purposes.
Be careful when gifting appreciated property. Because a property's basis (generally its cost) is carried over to the donee (the recipient), gifts of appreciated property (property that has increased in value) can be good in some circumstances but not in others. You may not want to give highly appreciated property if the donee will recognize a substantial capital gain when the property is sold.
Example(s): Gary pays $10,000 for stock in XYZ Company. Gary gives the stock to Ron as a birthday present. After several years, Ron sells the stock for $250,000. Since Ron is in a higher tax bracket than Gary (who is in the 15 percent tax bracket), he will pay income tax at a higher capital gain rate on the $240,000 ($250,000 - $10,000).
On the other hand, you may want to make that gift if the sale of the property is imminent anyway and the donee is in a lower income tax bracket.
Example(s): Ron pays $10,000 for stock in XYZ Company. Ron gives the stock to Gary as a birthday present. After several years, Gary sells the stock for $250,000. Since Gary is in a lower tax bracket (15 percent) than Ron, he will pay income tax at a lower capital gain rate on the $240,000 ($250,000 - $10,000).
You may increase the basis of appreciated property by the portion of federal gift and generation-skipping transfer taxes you pay that are attributable to the appreciation element. This means that the capital gain recognized by the donee may be less than it would be without the adjustment. You cannot increase the basis of the property you gave to the donee any higher than fair market value (FMV) on the date of the gift.
Caution: Try not to make gifts of appreciated property within one year of the donee's death if you are to receive the property back (the reverse gift technique). Such property will not receive the step-up in basis, and you may have needlessly paid gift taxes or used up your unified credit.
Tip: Contrary to lifetime gifts, the basis of property transferred upon death is stepped up (or down) to the FMV of the asset on your date of death. The one exception is property in an estate of a person who died in 2010. If such an estate elected out of the federal estate tax, estate property received a carryover or modified carryover basis and not a step-up in basis.
Property Owned Out of State
Generally, your estate is probated in the state in which you reside at the time of your death. If you also own real property outside the one in which you reside, another administration must occur in that other state. (This is known as ancillary probate.) Therefore, you might want to give away property you own in a state other than the one in which you live to avoid ancillary probate.
Property That Reduces Your Ownership to Qualify for a Discount
You may reduce your ownership interest in a closely held business (or an interest in real estate) so that it may be valued at a discount. For example, if you have a minority interest (49 percent or less) of the stock of a closely held business, you may qualify for a discount. Also, a fractional interest in real property may be valued at a discount. It may be beneficial to make a gift of stock or an interest in real estate to qualify for the discount.
Caution: This strategy may conflict with removing certain nonbusiness holdings to help your estate meet percentage tests to qualify for Section 303 (redemption of stock), Section 2032A (special use valuation), or Section 6166 (installment payout of taxes). If you want to preserve these benefits, it may be necessary to limit such gifts.
What Property Shouldn't You Give?
Property That Will Adversely Affect Your Standard of Living
Obviously, you should not give away property that you need to maintain your financial well-being. Do not give away assets that will reduce your standard of living. Be sure to consider the impact of any gift on your income, your capital needs (both present and future), and your need for liquidity.
Property That Is Likely to Depreciate (Lose Value)
Under the unified transfer tax system, lifetime gifts are added together with gifts made at death for the purposes of computing federal gift and estate tax. Generally, the value of the gift is its FMV at the time the gift is made. Therefore, you should avoid giving property that is likely to lose value after the gift has been made. The higher value of the gift when made will be added back into your estate for tax purposes. If you hold on to the property, it will be includable in your estate at the lower current FMV.
Depreciated (Loss) Property
Generally, it is not a good idea to give away depreciated (or loss) property. The donee's basis for recognizing a loss is the lower of your basis (carryover basis) or the FMV (stepped-up basis). The donee may be unable to recognize the loss on property. Both you and the donee may lose the loss deduction.
Example(s): Kevin and Tammy paid $80,000 (basis) for a bike shop. After several years of losses, they decide to give up the business. The FMV of the business is $50,000. They put it on the market but get no offer over $45,000 (selling price, or SP). If Kevin and Tammy had taken the offer, they would recognize a loss of $35,000 ($45,000 (SP) - $80,000 (basis)). However, Kevin and Tammy (the donors) decide to give the property to their son-in-law, David. Kevin and Tammy lose their loss and make a $50,000 (FMV) gift. A few weeks later, David is offered a great job in Chicago. David sells the shop for $45,000 (SP). David's basis for determining loss on the property is $50,000 (FMV) (the lower of the donor's basis ($80,000) and FMV). David's loss is only $5,000 ($45,000 (SP) - $50,000 (FMV)).
Tip: It is a better idea for you to sell the property, take the loss deduction, and give away the cash proceeds.
Property That Is Mortgaged for More than Its Basis (Cost)
You may own property that is mortgaged for more than its basis (cost). A gift of this property will result in taxable income to you in an amount equal to the excess of the mortgage balance over your basis.
Example(s): Steve buys a small island in 1969 for $15,000 (basis) in cash. Steve builds a small hotel on the beautiful island and immediately thousands of people begin to flock there to enjoy nature unspoiled. Steve sees great potential in the island as a tourist resort and convinces the bank to mortgage his island for $100,000 (mortgage), and Steve remains personally liable on the debt. Steve uses the money to build a bigger hotel. In 1970, Steve is offered a job on another island. The job is Steve's opportunity of a lifetime, so he gives his small island to his good friend, Mark, who assumes the mortgage and becomes liable in Steve's place. Steve has immediately realized taxable income of $85,000 (the mortgage of $100,000 - the basis of $15,000).
Gifts of Future Interest
A future interest gift postpones the donee's possession or enjoyment of the property until some time in the future. A gift of a future interest is not eligible for the $15,000 (in 2020) annual gift tax exclusion. You should avoid a future interest gift if the annual gift tax exclusion is a vital component of your estate plan.
Example(s): Ron gives his collection of jade carvings to his good friend on the condition that he gets to keep the carvings until his death. Ron has given his friend a future interest gift because he will not possess the carvings until after Ron's death.
Property with Positive Tax Characteristics
Avoid giving property that generates tax-exempt income (e.g., municipal bonds) or that shelters other income (e.g., depreciable assets), especially if you are in a high tax bracket.
Gifts That Will Result in Adverse Income Tax Consequences
Generally, making gifts will not cause you to realize income. However, there are some types of gifts that may cause you to recognize gain. For example, a gift of an installment obligation (installment notes receivable) will result in immediate recognition of the gain. The gain is measured by the difference between the FMV of the obligation at the time it is given and its basis. A gift of investment credit property may trigger a recapture of a portion of the credit that you received on the property.
Stock in a Closely Held Corporation
You must take care when gifting stock in a closely held corporation that you don't give away too much. If you retain too little of the stock, your estate may fail the percentage tests used to qualify for special tax treatment (e.g., Section 303, Section 2032A, Section 6166). In some circumstances, the benefits of making the gift will outweigh the loss of the special tax treatment otherwise available.
This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that focuses on transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.
The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.