Estate Planning
Use Care When Reducing the Amount of Your Estate While Living
Good estate planning may include the need for the reduction of your estate while you are still living. The idea behind lifetime gifts usually is to lower the amount of your estate that would be subject to estate taxes upon your death. And, like all areas of financial planning, careful consideration and planning can make a big difference.
The reasons for and advantages of gifting parts of an estate while still alive are varied. For some, watching heirs enjoy the gifts is more satisfying than knowing that assets will be distributed after death. For others, it is purely a matter of removing assets from the estate in order to reduce estate taxes (keep in mind that it is not just an asset's current value that is being removed from the estate, but also the value of any future appreciation of that asset). Whatever the motive, discretion and care should be used in order to avoid the potential pitfalls inherent in the process.
When making lifetime gifts, one of the key factors to consider is cost basis and whether you currently have a gain or a loss for that asset. The cost basis for a gifted asset that is later sold for a gain is the same as the asset's cost basis before the gift was made. This rule is easy to remember, but contrast it with what occurs when an asset is inherited. An inherited asset receives a "step up" in cost basis upon the death of the person who bequeathed it. The new cost basis of an inherited asset is thus its fair market value on the date of death (a few exceptions exist). Therefore, the cost basis for assets with considerable gains is more favorable for a recipient if they inherit them rather than receive them as a gift.
The cost basis for a gifted asset that is later sold at a loss can be a bit trickier to determine, because there are two possible values. The cost basis used is the lower of the donor's basis or the fair market value of the gift. That said, it becomes clear why gifting assets on which you currently have a loss is undesirable. If you gift said assets, you lose the ability to take the loss. Moreover, the loss does not carry over and apply to the recipient, rather it is permanently lost. In this case, the better bet would be to sell the assets yourself, take advantage of the loss on your income tax return, and then gift the proceeds of the sale.
Based purely on cost basis, then, in most cases it would be best to gift either assets that have small gains or the proceeds of the sale of assets that have a loss. You also have the option of gifting highly appreciated assets directly to charities. You reduce your income taxes by use of an itemized deduction equal to the fair market value of the assets, and the charities are generally exempt from paying taxes on the gains when they sell the assets.
A few other things should be kept in mind if you wish to reduce your estate by a large amount. Giving assets to family and friends in order to reduce your estate taxes will fail to accomplish that purpose if you live less than three years after making the gift. Additionally, there are drawbacks to gifting your home or partial ownership of your home while you are still living. Doing so creates a multiple-owner scenario that often brings complications. It also exposes the home to creditor claims against any of the owners. We recommend that you consult your estate-planning attorney and/or tax professional for guidance.
As of 2008, the tax-free limit for gifts is $12,000 per year per recipient. As in the past, there are a few exceptions to this limit. The limit does not apply to direct payments of tuition or medical expenses for another person (whether related to you or not). These payments are not considered gifts for gift tax purposes, as long as any such payments are made directly to the school or medical provider involved. There are also no limitations on gifts to spouses or charitable organizations (although there are limits on the tax benefits of charitable contributions).
If you are looking to reduce your estate, it is best that you enlist the advice and guidance of an experienced estate-planning attorney to help you. Pleasanton Financial Advisors can recommend skilled attorneys in the East Bay region.