upstream gifting

Gifting Gain Assets to get a Step Up at Death

Upstream Gifting and Gifting Gains

Can you gift your elderly parent an asset with massive capital gains? Sure! What if they held them until they get the step up in basis at death, and then you inherit them back? No one ever pays the capital gains!

While death and taxes are not fun to think about, both will happen. Upon death, when you inherit an asset, its basis gets stepped up. Also, you are allowed to gift anyone 15k a year… even a parent! And if we put the two facts together…

Why not gift away a low basis asset and get it back a few years later with a step up in basis? Let’s talk about upstream gifting and how it might help you erase some capital gains on highly appreciated assets.

An Example of Gifting Gains

Let’s say you have a mother who is elderly and will pass on in the next few years. If she is set financially and doesn’t need money, why not gift anyway to get a tax break?

Imagine you have 15k of stock that you paid 1k for. If you sold it, you pay 14k in capital gains tax. Instead, use your yearly gift exclusion to give it to Mom. That is, directly transfer the shares from your brokerage account to hers. She gets the pleasure of paying taxes on the dividends each year, hopefully at her lower rate.

Then, when she passes, you get the 15k in stock back. Maybe it is worth more than 15k now, but the basis of the stock resets the day she dies. It gets a step up in basis. When you gave it to her, it kept the 1k basis since gifts retain their basis. After death, however, assets get stepped up and capital gains erased. That is, the stock is now has the basis on her day of death, so instead of 14k of capital gains taxes, you owe zero if you sell the stock right after you inherit it back.

Gifting Gains

This gain gifting works well when you keep under the yearly gift exclusion of 15k a year. You and your spouse, however, can give 60k to your mom and dad, as this is 15k x 4. You will have to fill out a gift splitting form with your taxes, but you do not lose out on your lifetime estate tax exclusion.

Directly transfer the shares from brokerage account to brokerage account. No selling to cash and transferring that.

Highly appreciated real estate is also a possibility, but you would consume some of your lifetime estate tax exclusion. This may or may not be an issues upon your death (depending on the size of your estate and how much they cut the estate tax exclusion is in the future).

Understand that when you gift an asset, the basis transfers. You can give gifts to anyone. If you give your kids (who are in a lower capital gains bracket) appreciated assets, they can sell them and recognize the capital gains at a lower tax rate.

Downstream Gifting

Let’s look at an example of gifting to your kids. This is called downstream gifting.

So here, assume you are in the 23.8% capital gains tax bracket, but your kids are under the 12% federal income tax bracket for ordinary taxes. They still have some room in their 0% capital gains bracket. If you gift them appreciated securities, they may be able to sell the asset, recognize the gain, but pay no taxes on it.

When considering downstream gifting, don’t forget about kiddie tax if you claim your children on your tax return. They can still have $2,200 of net unearned income a year, which may help during college age. This gets complicated and is beyond the scope of what I want to discuss here.

Giving to your kids is downstream gifting. Giving to your parents is called upstream gifting.

Upstream Gifting to your Parents

Why might you want to gift to your parents?

There are a lot of reasons! They might be in a lower capital gains bracket than you are, and like the example above, be able to recognize capital gains at 0 or 15% when you would pay 18.8% (above the NIIT income limit) or even 23.8%. Remember, there actually is no 20% capital gains bracket, review my bit on Capital Gains if you need to.

Note that the gift must be made at least a year in advance of death. If you gift on the deathbed, the gift reverts back without a step up in basis.

And make sure that Mom doesn’t get a new boyfriend and leave him the assets. After all, once you gifted, they are hers to do with as she pleases!

Other Issues in Upstream Gifting

Step up in basis

You can gift lots of things. Stocks, ETFs, mutual funds can all be moved electronically from account to account. Once the shares are in their brokerage account, the basis should transfer as well.

At death, you get a step up in basis for inherited assets. Instead of the basis recorded, once the custodian gets a copy of the death certificate and transfers the assets to your account, the new basis should be stepped up to the date of death. Hopefully you die when the market is up, but that’s pretty morbid!

The Usual Point of Yearly Exclusion Gifting

Generally, we think about yearly exclusionary gifting if you are up against the estate tax limit. A couple can give their married child 60k a year. That is, each parent can give each of the couple 15k. The parents will need to fill out a gift-split form when they do their taxes, but this is a way to get money out of your estate.

This usually works best if you give something that is going to appreciate between now and when estate taxes are due. So, for example, you could put your business in an LLC and then gift shares of the LLC that will be worth much more in 10 years. Then, when you pass, the growth of the assets are in your kid’s name already, and not part of your estate.

Gifting between Elderly in Non-Community Property States

Ownership is also a consideration between spouses in non-community property states. There is “gifting” between spouses, but you have an unlimited marital deduction, so there are no limits on intra-marriage gifting.

You get a full step up in basis of all assets any time either spouse dies in a community property state. Seems like most people don’t understand this, and it can be tricky when you move to a non-community property state.

In non-community property states, have the spouse who will die first own all the low basis assets in their name. Then when the other spouse inherits them, they will get a full step up, rather than just a ½ step up that you would otherwise get if owned joint.

Don’t Gift Loss Property

Just as a reminder, or take note if you haven’t heard this before, never give loss property. If you have a loss on the asset, sell and recognize the loss, and then give away the cash.

If you give loss property, the loss doesn’t transfer, and the asset has a split double basis. Don’t worry about the behind-the-scene numbers, just understand that you don’t gift losses. Ok?

Don’t Gift Assets Before Death

While we are on the topic of what not to do, don’t gift appreciated assets before death. If you leave them in your will instead (or beneficiary form, or trust, or transfer-on-death account), you will get the step up in basis. If you gift them, they basis transfers and you lose the step up!

This is a not-infrequent mistake around titling of the home. If you put your children on the title of your home before death thinking it will be easier to transfer the home, you lose the step up in basis on the home! Putting someone on the title is a gift of the property, thus it does not get a full step up. This can be a massive mistake as each individual gets 250k of free step up in the home value when they sell (or die).

Summary: Upstream Gifting and Gifting Assets

In summary, you can take advantage of lower capital gains brackets by upstream or downstream gifting to the yearly gift tax exclusion. Don’t gift loss property! Take the loss.

Downstream gifting has the complications of kiddie tax, but upstream gifting has the advantage of step up in basis upon death. Even if you don’t think you are going to have estate tax issues, giving highly-appreciated assets to your parent is a consideration.

I have a other great stuff on tax-efficient gifting to your heirs, and if you have charitable intent, consider the best way to give it all away.

These maneuvers don’t take a ton of time and can save thousands of dollars in capital gains taxes. Not a bad return on investment as every dollar the government doesn’t is another one to spend or given away.

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6 Comments

  1. As somebody who is HENRY with an aging parent in a lower income bracket, this is great to know!

  2. For a separate property state, if a healthy spouse gifts a low cost basis investment asset that is jointly held into the terminally ill spouse’s own investment account, does the 1 year rule still apply in order to get the full stepped up basis upon the death of the terminally ill spouse……….instead of a 50% stepped up basis if the low cost investment asset had not been transferred from joint ownership?

    • I’ll say I don’t know! It would make sense but sometimes the IRS makes no sense…

    • Yes of course it works. Tax code, as they say, is written in pencil. It can always be changed…

  3. You did a great job explaining this is a well understood strategy. But the political winds are blowing and Biden is proposing to take it away. To compound the issue, the low basis would not transfer — the CG taxes will be at death. If this gets passed, heirs will have to pay the CG taxes AND possibly estate taxes! I see fire-sale prices for the illiquid family farms and family owned businesses.

    Or it will keep the attorney’s busy with new approaches.

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