Gifting vs Inheriting

Gifting vs. Inheriting

All of you are probably aware of income tax and sales tax. You know your taxed when you buy something, you’re taxed when you earn income. Well, guess what? You are also taxed when you die. It is the estate tax, morbidly, sometimes referred to as the death tax, and it is different than those taxes because it is what is essentially a value tax. It is a tax on the value of assets that a taxpayer owns at the time of their passing. So an estate tax form is prepared and filled out and lists basically the entire inventory of assets that a taxpayer has. And that value of those assets is valued at what’s called fair market value at the time of their passing. And it this sounds kind of a little bit depressing there is some good news, and that is that there is a lifetime exemption amount that can be used against the taxable estate of a taxpayer.

Each person has a lifetime exemption that they can use to offset the amount of estate tax that they will have, that they could possibly be subject to. And that amount right now in 2023 is close to $13 million. And I say 2023 specifically because that amount, the amount of the lifetime exemption can change from year to year. In 2017, we actually saw the lifetime exemption amount nearly double as part of the Tax Cuts and Jobs Act, where it was around five and a half million dollars. And that is set to sunset in at by the end of 2025. So at 2026, beginning with the year 2026, that lifetime exemption amount, if Congress doesn’t change anything or pass anything to the contrary, will fall back down to five and a half million. Still a nice amount, in my opinion. But you might be wondering, well, okay, if we got this lifetime exemption amount of five and a half million, that’s great. But are we able if we’re close to that or we feel like we are you know, we might be subject to an estate tax, are we able to transfer those assets out of our estate so that we’re not subject to the estate tax?

Some of you might be thinking, well, what about gifting as an option? And that’s a really logical train of thought. So much so that Congress and the IRS were thinking, well, in order to prevent people from completely avoiding estate tax altogether, there’s going to be some limitations and rules to keep in mind when gifting property. So gifting is actually very much heavily tied to the estate tax and in particular the lifetime exemption amount. So the idea is, that if you’re gifting assets to somebody else other than your spouse, the amount of your lifetime exemption decreases by the amount of gifts, taxable gifts that you make. So you’re like, okay, well, if that’s the case, is there really any benefit to gifting if, you know, we’re just basically recapturing it when calculating our taxable estate? Well, the answer is, actually it can.

There is an annual gifting exemption that taxpayers can use during the year that they make a gift to somebody, an individual. So, for example, in 2023, that amount is $17,000. So I can gift $17,000 to an individual and it does not impact my lifetime exemption amount. It’s not what would be considered a taxable gift. And I can make that $17,000 to each individual person. So say if I had two friends and I wanted to give them each $17,000, that’s $34,000 that I can give to them that is free from any gift tax implications. If I were married and me, my wife would like to gift, you know, to these two friends. We are both able to contribute $17,000 each to those two friends. So, the math, that’s $68,000, right. 17+1=34. Double that. 68. that $68,000 that both of us as spouses can gift and we’re okay. So that’s how that annual exemption amount works. And that’s a useful tool to use when doing estate planning, when you’re thinking about trying to whittle down the amount of all, excuse me, amount of taxable assets that would be included in your estate, subject to the estate tax.

The other concept to keep in mind when we are looking at these avenues of property transfers is the concept of basis. And I’m not sure how familiar you all are with that, but as either an introduction or a quick, simple recap of what it is, think of basis as your investment in an asset. And that’s important. It is literally half of the equation when you are calculating capital gains from property transfers or sales, rather, that is subject to income tax. So, when you sell property, you’re not taxed exclusively on the proceeds that you receive. You are taxed on the gain. Hopefully gains sometimes could be a loss on the sale of that asset. And so the equation is your proceeds minus the basis, your investment is equal to the gain or loss that’s subject to income tax. In that case you are thinking, okay, capital gain basis is pretty important in this. How is this at all impacted with gifting and inheriting property? Well, for gifting, you might be wondering, okay, if I receive as a gift or I inherit property, what is my investment? I did not pay anything for it because when we think of basis like a simple example would be if I purchased stock for $20, $20 in cash and later down the road I sell it for $80, what is my gain? 80 -20 is $60. But again, I’m using basis as an illustration for when I purchase something with cash. But if I didn’t purchase it, if I inherited property or if I was gifted property, is my basis. zero? Well, the answer is no.

Your basis is going to be determined depending on whether you inherited it or whether it was gifted. If you received the asset in one of those two ways. If you were to inherit property, what is your basis in that property? Your property, your basis in that property that was inherited is going to be the fair market value at the date of death of the person that you’ve inherited it from. As opposed to when it is gifted to you, that basis is going to be, if well, you’re going to have to think, you’re going to have to know a couple of pieces of information to know what that basis is. I am going to try to simplify it a little bit.

Generally, the basis is going to be the basis at the time the gift was given to you by the donor. So, it’s the donor basis that basically transfers over to you as the recipient. If a fair market value at the time of the gift is less than or greater than what the donor adjusted basis is, that’s where you kind of have to do some calculating to see what, if the basis is either the donor adjusted basis or whether it’s the fair market value at the time of the gift, or if it falls in between. If the sales price falls between those two amounts, you might end up in a situation where your basis is going to equal to the sales price. But without trying to get things complicated in terms of illustrating these concepts, I’m just going to focus primarily on the basis being equal to the donor’s basis. So, we’ve got, you know, these basis considerations and we’ve got the estate tax to think of.

So then you’re thinking, okay, well, when we’re assessing this, what is the ultimate strategy or what strategies should we be thinking about when making these decisions on whether to gift or whether to hold on and with the intent to have your beneficiaries inherit the property?  So when we’re talking about, you know, basis and fair market value for talking about property like real estate property, farmland property, which generally increases in value, the idea might be, well, it might be better to have somebody inherit that property because if, if the asset appreciates over time and you’re holding it as long as you possibly can, the idea is, is that the fair market value will be higher at the time of your passing as opposed to when you would gift it, you know, years before. So, if the basis is higher, then whoever inherits that property, the idea is the amount of capital gains that they would be subject to if and when they disposed of or sold, that asset would be less. So that is a consideration. But then also to, what about gifting? Then we’re like, okay, well, if that’s a plus for inheriting property, what about gifting?

Well, as I had mentioned earlier, there’s that exemption amount, that annual exemption amount that you can use to basically gift out pieces of your assets that are underneath that amount or equal to that annual exemption amount that you can basically “give away” for free without any kind of gift tax consequences. So that’s a strategy that can be utilized to reduce the amount of taxable estate that would be subject to the estate tax. The key takeaway of all this is like, well, okay, you are saying in these cases it could be better to gift. In these cases, it could be better to inherit. What is the general answer or what’s the best, what’s the best strategy to utilize? And honestly you’re going to hear this a lot when you talk to tax practitioners, it depends on the facts and circumstances of the client that you’re working with or you yourself, find yourself in that in that situation are faced with. So, you know what assets are being held. For example, like if you’ve got somebody who has an estate that has mostly like property, real estate, property, that’s not necessarily liquid, well, okay, if you were to hold on to that property and not gift it out and you’re holding it and you’re like, okay, we’re going to have it be subject to estate tax. Do you as a taxpayer, have enough liquid assets to pay any estate tax that would be due without selling property that you would ideally like to pass on to your heirs?

So that is a consideration to make. And then what is the intent of the inheritor or the recipient, say, for example, that the inheritor wants to just hold the property. It is a family farm. They want that property in their family, you know, and intend to pass it on to their heirs. Well, then, are we as concerned with the basis that they would receive for that property? If not, you know if the intent is to go ahead and sell it, should we then be focusing more on a basis issue to potentially reduce any capital gain that they could eventually be subject to when it comes to income tax, when they sell it? So all these are important considerations to make and require a lot of planning and sometimes that’s not always pleasant, right?

We are talking about estate planning, which can be a prickly issue for some people. You know you are talking about either your own mortality or the mortality of a family member or a loved one. But the general idea is that it’s better to plan for these things beforehand as opposed to when you get to the time of death and, you know you’re already in a situation where you’re grieving and you’re having to deal with this stuff as well. So that things that are important to keep in mind and it affects, you know, in like, well, our taxable estate is not going to be, you know, anywhere near these amounts. Again, these exemptions change over time. And for gifting purposes, you know, a lot of us, even if you are not subject to estate tax, we are going to be utilizing gifting in some ways or another. And what are the tax implications for that?

So, things that are important to keep in mind and documentation is particularly important as you’re going through all of these things.

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