Thoughtful Gifting Part 3: Stocks, Bonds, Real Estate or Cash? What to Give to Maximize Tax Benefits

09.01.2021 - Nita S. Vyas, Trust Counsel

Thoughtful Gifting Part 3:This is the third piece in a four-part series on the federal gift and estate tax, what the future might hold for the exemption amount, and why you should consider making large gifts in 2021.

Thoughtful Gifting Part 1
Thoughtful Gifting Part 2
Thoughtful Gifting Part 4

The federal estate and gift tax exemption is at its highest level ever, meaning you can leave a significant amount to your heirs—$23.4 million for married couples—free of federal gift or estate tax.  But this exemption is scheduled to be cut in half in 2026 and may be reduced even sooner by legislative change. It may make sense to make gifts to use your exemption amount now, before these potential changes take place.

Deciding to Give Away Assets Now

From a federal estate tax perspective, the most important factors to consider in deciding to make lifetime gifts are:

  • The current value and income tax basis of your assets
  • What you think your assets will be worth in the future
  • The extent to which you think the federal estate tax will apply to your assets in the future

Gifting typically has clear tax benefits if your assets well exceed the current exemption amount. Gifting can also provide benefits if you think your assets will grow substantially in the future, and those benefits may be amplified by changes in the tax rules.  For example, gifting your interest in a closely-held company now may yield massive tax benefits as the company grows and the appreciation falls in the hands of your beneficiaries and not in your estate. 

Gifting may additionally allow you to take advantage of valuation discounts and other estate planning techniques that might not be available in the future.  Gift also could bring advantages for estate taxes at the state level.    

Which Assets You Give Is Just as Important as How Much You Give

To maximize the tax benefits of a gift, it’s crucial to choose the right assets. 

A main concern with gifting an asset is that your beneficiary will receive it with the same income tax cost basis you have, which can result in a large capital gains tax bill when he or she sells. This is different from what happens when beneficiaries receive assets at your death. In that case the assets receive a “step-up” to their current market value—and the capital gains tax disappears.

For instance, if you sell an asset worth $10 million and it has a tax basis of $1 million, $9 million will be subject to capital gains tax. The same tax applies to your beneficiaries if they sell the asset after you give them the asset during your lifetime. In contrast, if you retain the assets and transfer it to them as part of your estate at death, the gain goes away.  Depending on the size of your estate, you may essentially trade a capital gains tax for an estate tax.

Like the estate tax exemption amount, the “step-up” in basis rules are not set in stone and could be a tax benefit that disappears.  Nevertheless, careful consideration of both the estate and income tax consequences of any proposed gift is critical.

In general, the best assets to gift:

  • Are likely to appreciate in the future.
  • Have a high income tax basis relative to their current value.
  • Will not be needed for personal use or living expenses.
  • Offer the potential for valuation discounts.
  • Are holdings you are comfortable giving up control of.

Typically, there is a trade-off among the various factors. Valuation discounts can result in significant appreciation potential out of the gates. It is important to evaluate the potential “tax cost” of sacrificing the step-up of basis. You also need to recognize when giving up control or use of assets may cause complications.

What Assets Are the Easiest to Give?

Sometimes the best assets to give are the ones that are easiest to transfer. Cash is often a welcome gift. There’s no sacrifice of a capital gains step-up with cash. And your beneficiaries can easily invest that cash in appreciating assets. Similarly, you can forgive promissory notes without sacrificing the step-up, and the emotional benefits of forgiving a loan can be significant.

Second homes sometimes make for simple yet powerful gifts because the property is relatively easy to transfer a deed into a trust. Gifting partial interests in real property can offer valuation discounts and can be especially helpful if the whole family is already sharing the use of that property. Another easy option can be recent investments in private holdings that offer the potential for considerable appreciation.

Conversely, a recently acquired real estate investment may appear to be an attractive gift because it has a high income tax basis and potential for valuation discount. But if you want to retain control over the property, it probably isn’t an appropriate gift.

Gifting with a Trust Can Be a Good Idea

Remember large gifts are usually placed in trust.

For tax purposes, applying your generation-skipping transfer (GST) tax exemption to the gifts you place in trust could help your family avoid the federal estate tax on those assets for multiple generations–if current rules on GST tax continue to apply. And locating your trust in a trust-friendly state like Delaware might also reduce or eliminate state-level income taxes for the trust.

Trusts allow you to direct what ultimately happens with your gifts. You can craft the trust document to specify your intentions for the gift, set the timing and conditions for distributions, and create a framework to guide trustees and help them make the best decisions for you and your beneficiaries.

In many cases, assets placed in trust as a gift require special skills to manage and invest effectively. A professional trustee like Fiduciary Trust can ensure those assets are managed to effectively serve all beneficiaries, current and future, over the long term.

It is also possible to separate the responsibilities of the trustee by using a directed trust. With a directed trust, a corporate trustee such as Fiduciary Trust serves as the administrative trustee to handle all recordkeeping, custody of assets, and tax reporting requirements. You can appoint a separate trustee to make investment decisions and, if appropriate, another trustee to direct distributions to beneficiaries. Directed trusts can be particularly useful with private holdings, like LLC interests or real property, because investment decisions can remain with the family instead of being subject to the normal requirement of a trustee to diversify the trust’s investments. 

Finally, a trust can help beneficiaries protect assets from creditors and divorce claims.

Create Your Gifting Strategy Today

Making large gifts takes time, analysis and careful planning. When done well, they can establish a family legacy that endures for many generations and saves millions in taxes along the way. At Fiduciary Trust, our tax and estate planning professionals have been helping families make large gifts since our founding in 1931. Please contact us to determine if making a larger gift using your exemption in 2021 is something you should consider.

This communication is intended solely to provide general information. The information and opinions stated may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. You should seek advice based on your particular circumstances from your tax advisor.

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