It was once commonly believed that it was best to make gifts of your assets during your life rather than wait until your death to pass them to your loved ones. This was based on the idea that doing so would allow you to avoid paying taxes on the assets in the form of estate tax. However, this is not always the case, and the analysis is based largely on the current estate tax exemption amount, current estate and income tax rates, as well as the income tax basis of the assets in question. Depending on the answers to these variables, sometimes you will end up paying less in total taxes by retaining your assets until your death.
When analyzing whether to gift or bequest a certain asset, the first step should be to determine the income tax basis of the asset. The income tax basis is the value of the asset when you acquired it. This is relevant because both New York State and the federal government impose a capital gains tax on the difference between the initial value of the asset and the value of the asset when it is sold or gifted (the “capital gain”). However, when you hold onto an asset and bequeath it upon your death, the tax basis is “stepped up” to the date of death value of the asset and the beneficiary will have a new tax basis on the asset and will only pay capital gains taxes on the appreciation of the asset between your death and when they choose to sell the asset. Therefore, if you are considering gifting assets that have appreciated significantly over your lifetime, it might make sense to consider bequeathing them at your death, letting your beneficiary receive a stepped-up basis and thereby reducing the potential capital gains taxes they owe.
The current combined New York State and federal capital gains tax rate can be as high as around 31.5% (higher still for those living in New York City), while the top federal estate and gift tax rate is 40% with New York’s estate tax rate maxing out at 16%.
The current federal gift and estate tax exemption amount is $13.61 million and the New York State estate tax exemption amount is $6.94 million. This means that no estate taxes will be owed on any assets under $6.94 million passing to a beneficiary at your death and no federal estate taxes will be due until you have bequeathed more than $13.61 million.
Consider the following illustration: Olivia has a son, Greg. Olivia owns a ten (10) million-dollar home that she purchased for $1 million (making her income tax basis $1 million). She owns no other assets. She would like to see her home pass to her son with the smallest possible potential tax liability.
Example 1 – Gift the Home
Olivia gifts the $10 million house to Greg in June of 2021. There is no federal gift tax, as the value of the gift ($10 million) is under Olivia’s federal gift tax exemption. Greg sells the house in November 2021 for $12 million, recognizing a capital gain of $11 million.
What are the tax consequences? The Federal & NYS Gift Tax is $0 and the New York Estate Tax is $0. However, the Capital Gains Tax is approximately $3,465,000.
Example 2 – Bequeath the Home in a Will or Trust
Olivia retains the house until she dies in March 2024. Olivia bequeaths the house to Greg under Olivia’s will or Trust. Greg sells the home in September 2024 for $12 million.
What are the tax consequences in this example? The Federal Estate Tax is $0 since the estate is below the federal limit. The New York Esate Estate Tax is $1,386,800 (tax on the $12 million estate) and the Capital Gains Tax is $0 since the home’s stepped-up value is $12 million), bringing the Total Tax to approximately $1,386,000.
By retaining the house until her death, rather than gifting it outright to her children, the total taxes owed by Finn and Ruby was reduced by $2,079,000. This clearly demonstrates the value of balancing the potential estate taxes due at death against the capital gains taxes owed when the assets are eventually sold.
Call the attorneys at the Law Offices of Roman Aminov, P.C. at 347-766-2685 if you are considering engaging in gifting as part of your estate plan. Sometimes it pays to carry assets until your death. Engaging an experienced estate attorney near you to assist you in analyzing what is best based on your unique estate could potentially save your family significantly in taxes.
This article is for educational purposes only - to provide you with general information, not to provide specific legal advice. Use of this post does not create an attorney-client relationship and information contained herein should not be used as a substitute for competent legal advice from a licensed attorney in your state.
