Often people will transfer title of their assets to their adult children while they are living, thinking it will make things easier for their children when something happens to them.  Doing this will prevent the court from controlling the assets if you become incapacitated and it will avoid probate when you die.  However, while there can be valid tax reasons to transfer some assets now, it can also create some serious problems.

Here’s the reality.  First, when you give away an asset, it’s gone. You may think your children will give it back to you if you change your mind, but they don’t have to and you can’t make them.  Also, we all know how family dynamics can drastically change when money is involved. They can do anything they want with the asset given to them: they could sell the asset against your wishes (e.g. a priceless family heirloom or jewelry with significant sentimental value). They could lose it to creditors or be influenced by a maliciously intentioned spouse (sorry, but they’re not a myth and have been know to exist in even the best of families).  If you outlive your children or they divorce, the ex-spouse could end up owning the asset and all of a sudden someone who you never intended to have it now owns your great grandmother’s one of a kind porcelain teapot collection.

Second, there could be tax problems with gifting to your kids. Currently, when you give someone other than your spouse more than $13,000 in one year, the gift tax may get involved.  That means if the gift has a value of more than $13,000, you must file a gift tax return and the IRS will be none too happy with you.  We all know how forgiving the IRS can be, so you may not need to worry about this failure to file.  Oh wait a second, I’m getting confused; it’s my mother who’s forgiving … not the IRS.  File the return.

One more big problem, when your children sell the asset, there will probably be a capital gains tax because, under current law, the asset would not receive a stepped-up basis.  The basis of an asset is the value used to determine gain or loss for income tax purposes; in other words, the basis is what you paid for the asset. If you give an appreciated asset to your children while you are living, it keeps your old basis (what you paid for it). However, if they receive it as an inheritance after you die, it receives a new stepped-up basis and is subsequently revalued as of the date of your death.  Not a fun topic to think about but let’s look at why you should pay attention.

Here’s an example.  Let’s say you purchased your home for $500,000 and it’s worth $1,000,000 when you die. If your children receive it as an inheritance after you die, the basis would be $1,000,000.  If they then sell it for $1,000,000 there would be no gain and thus no capital gains tax.

Part two of the example.  If you give the house to your kids while you are living, the basis would be $500,000 (what you paid for it). If they sold it for $1,000,000, they would have a $500,000 capital gain and would have to pay $75,000 in capital gains tax. Currently, the top capital gains rate on assets held longer than 12 months is 15%.  On one hand $0 and on the other $75,000 straight to the IRS.  Hmm, what to do?  What to do?

Substantial gifts may also disqualify you from receiving Medicaid and SSI (Supplemental Security Income) benefits for a significant period of time.  A good estate planning attorney can help ensure that your plan does not disqualify you from receiving these benefits through proper planning techniques.

Gifting can be a great way to reduce estate taxes if your estate is larger and you can afford to give away an asset.  Just remember to never give away an asset you may need later and make sure you consult with an experienced professional.  If you’ve still got question, give us a call at 858-384-5757 or check us out on the web at www.yourtotalestateplan.com.