UpStream Gifting: How Taxes Factor into Gifts
The Logistics of Gifting and Taxes
Gifting from one generation to the next is common. For example, parents often gift cash and/or securities to their adult children to help with real estate purchases, start a business, or pay off debts. Grandparents often help out with tuition funding. These are examples of gifting "downstream" to succeeding generations.
The tax logistics of gifting are often misunderstood. The 2020 annual gift tax exclusion remains at $15,000 per donor or ($30,000 per couple). In theory, a person/couple could gift this amount to any number of people and not be required to file a gift tax return (IRS Form 709). Gifts in excess of these amounts require the filing of a gift tax return to document the portion of the donor’s $30,000,000 lifetime gift tax exemption ($11,580,000 per couple) that has been used up by the gift, but, until this figure has been used up, the donor(s) will owe no gift tax.
Gift recipients (“donees”) do not owe any tax on the amounts received. However, if the assets that are gifted have appreciated in value, the donor’s original cost bases transfer to the donee. Thus, if a parent gifts a child appreciated securities or real estate, the child must pay tax on the capital gain based upon the parent’s original cost and date of purchase.
In some cases, downstream gifting of appreciated assets, such as stocks, to children or grandchildren in lower tax brackets may be shrewd tax planning. In other cases, it may be ill-advised. For instance, gifts of highly appreciated real estate or stocks from elderly parents to children may be poor tax planning, since these assets may receive a step-up in basis (thus, avoiding capital gains tax), if they were transferred via inheritance instead.
While downstream gifting is fairly common, most people are unfamiliar with the potential planning benefits of "upstream" gifting. A common example of where this may make sense is the transfer of appreciate stock or real estate to an elderly parent(s) who may be in a lower marginal income tax bracket.
This may be done to assist in paying long term care expenses or merely as a tax planning strategy for receiving the asset back in the future through inheritance with a stepped up cost basis. This is sometimes accomplished via a Transfer on Death (T.O.D.) agreement for stocks or a Transfer on Death Deed for real estate.
If implemented properly and in the right circumstances, upstream gifting can be a great way to side-step or significantly reduce long term capital gains tax. It is a strategy we have introduced in a number of client conversations over the past couple of years, and it offers a great example of the value of financial planning guidance.
This article was originally published in 2017, but has since been updated with current information.
For more on this topic, see the following article links:
Gift Tax Returns: What You Need To Know (Forbes)
Dangers of Giving Your Home to Your Children(Wall Street Journal)
Upstream Gifts to Your Parents. Potentially Significant Income (Estate) Tax Savings (James M. Kane Legal Blog)
Estate Planning: Five Ways to Keep Capital Gains Taxes Low (KLR Global Tax Blog)
Ten Estate Planning Strategies While Waiting for Tax Reform (Wealth Management.com)