We all like to see our assets appreciate in value, but we don't like to pay the taxes on the gain when we sell an asset. So let's discuss an often overlooked tax provision that could eliminate capital gains taxes. First, some ground rules:
Sorry, but we need to get just a touch technical here. The starting point in determining the amount of gain you will be taxed on is to figure out the tax basis of the asset. Basis is a technical tax term that roughly equates to the purchase price of an asset, with perhaps some adjustments. To keep this simple, we won't delve into what adjustments are made to purchase price, but you should consult your tax advisor before you sell a capital asset to be sure that you have figured the amount of gain correctly. The difference between the tax basis and the sales proceeds is either a capital gain or loss.
Now for the planning idea. It involves capital assets that you hold at your death. A provision in the tax law allows the capital gain to be eliminated if a capital asset is held in your estate at your death. This is accomplished by virtue of receiving a new tax basis in the asset equal to its date of death value. Let's say that you bought Apple stock at $50 per share. Let's also assume that you hold the shares until your death when they are worth $150 per share. You heirs will receive the stock with a new tax basis of $150, meaning that the $100 capital gain has been eliminated.
So, what should you be thinking about? Let's use your home as an example. If you own your home jointly, as many married couples do, one-half of the value is included in the estate of the first spouse to die. So, only one-half of the home gets a stepped-up basis at death. If instead, the first spouse to die owned the entire home, the surviving spouse would receive the home with a full basis step-up. That means a sale of the home at that point would produce no capital gains tax unless it is sold for a value higher than the date of death value. Of course, in most cases, it isn't certain which spouse will die first. However in some cases, due to age differences or illnesses, it might be more predictable.
Something else to think about is the ownership of securities with a very low tax basis, or said another way, a very large capital gain, that are held by elderly family members. If the securities are owned at death, they get a full tax basis step-up, eliminating all capital gain. You might want to think twice before selling securities with a large capital gain if the owner is infirm or elderly.
The reverse is true for assets that have fallen in value since they were purchased. The provision that eliminates the gain at death also eliminates the loss at death. So if you have an asset with a large capital loss, you may want to sell it before death in order to get the tax benefit of the loss. The primary tax benefit to a capital loss is that it offsets capital gains, but only those that are taken before death.
One wrinkle to consider – if you transfer the ownership of an asset within one year of the date of death, you don't get the step-up. The IRS assumes that it was done to avoid taxes. The ownership of assets at death have consequences well beyond capital gain tax planning, so you need to consult with your tax advisor and/or estate planning attorney before making any changes. But paying attention to asset ownership you could have significant tax savings for the family.
For informational purposes only. Consult with your tax professional regarding your specific situation.