Estate planning and income tax basis

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Income tax basis can be important when deciding whether to make gifts now or transfer property at your death. This is because the income tax basis of the person receiving the property depends on whether the transfer is by gift or at death. This, in turn, affects the amount of taxable gain subject to income tax when the person sells the property.

Income tax basis
Income tax basis is the base figure you use when determining whether you have recognized capital gain or loss on the sale of property for income tax purposes. (Gain or loss on the sale of property equals the difference between your adjusted tax basis and the amount you realize upon the sale of the property). When you purchase property, your basis is generally equal to the purchase price. However, there may be some adjustments made to basis. 

Income tax basis for property you receive by gift
When you receive a gift, you generally take the donor’s basis in the property. (This is often referred to as a “carryover” or “transferred” basis). The carried-over basis is increased — but not above fair market value (FMV) — by any gift tax paid that is attributable to appreciation in value of the gift (appreciation is equal to the excess of FMV over the donor’s basis in the gift immediately before the gift). However, when determining loss on a subsequent sale, the carried-over basis cannot exceed the FMV of the property at the time of the gift.

Income tax basis for property you inherit
When you inherit property, you generally receive an initial basis in property equal to the property’s FMV. The FMV is established on the date of death or on an alternate valuation date six months after death. This is often referred to as a “stepped-up basis,” since basis is typically stepped up to FMV. However, basis can also be “stepped down” to FMV.

Make gift now or transfer at death?
Income tax basis can be important when deciding whether to make gifts now or transfer property at your death.

Example: You purchased land for $25,000. It is now worth $250,000. You give the property to your child who then has a tax basis of $25,000. If your child sells the land for $250,000, your child would have a taxable gain of $225,000.

If instead, you kept the land and transferred it to your child at your death when the land is worth $250,000, your child would have a tax basis of $250,000. If your child sells the land for $250,000, your child would have no taxable gain. 

Also consider the following:

  • Will making gifts reduce your combined gift and estate taxes?
  • Does the recipient need a gift now or can it wait?
  • What are the marginal income tax rates of you and the recipient?
  • Do you have other property or cash that you could give?
  • Can you afford to make a gift now?
 Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016.

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