Tax Issues & Consequences related to Gifting an Asset

You must carefully consider the concepts of “step-up in basis” and “carry-over basis”.

When you (the donor) make a lifetime gift, the recipient of your gift (the donee) takes over your cost basis.  In other words, your cost basis for the gift is “carried over” to the recipient.  For example, a carry-over basis may apply when you transfer your house for no consideration to your family member directly, or to certain types of Irrevocable Trusts. This can have potentially significant capital gains tax liabilities for the donee, because the recipient would be responsible for the tax on the unrealized gain accrued by the donor when the donee sells the asset.

On the other hand, the general rule is that when an individual dies with assets owned by him (or deemed as owned by him) at the time of his death, those assets are included in his estate for tax purposes.  As a result, those assets receive a revised value, based on the fair market value at the time of his death; that is, the assets receive a “stepped-up” basis.  This stepped-up basis on inherited property eliminates income tax on unrealized gain that was accrued by the decedent. This means that when the beneficiary sells the asset with a “stepped-up” basis shortly thereafter, the beneficiary would not incur capital gains tax.  This result therefore may be dramatically different (and depending on the circumstances preferable) than if the decedent had gifted the same asset to the same recipient during the decedent’s lifetime.

As discussed above, there is a tension between the concepts or effects of “carry-over basis” versus “carry-over basis.”  Put differently, hoped-for estate tax savings by removing an asset from your estate by way of a lifetime gift may be outweighed by the loss of a stepped-up basis and by the resulting capital gains tax liability to the recipient.  Therefore, before you do any significant gifting, this will require a careful analysis of whether any potential benefits of removing assets from your gross estate may be outweighed by causing potentially significant income tax liabilities for your beneficiaries.  Please contact Abraham Mazloumi & Associates if you wish to discuss these issues in greater detail.