Gifts, Cost Basis and Capital Gains

[Jeff Matthews]

Something some of you might want to know...

 

When you buy property (real estate, equipment, etc.), your cost basis is the purchase price.  Say, for example, you bought a rental home 20 years ago for $65,000 and now it is worth $300,000.  If you sell today for $300,000, you have a capital gain of $235,000.  You'll owe a chunk to Uncle Sam.  Even worse, you probably depreciated the property for the 20 years, and its basis is even lower, meaning your tax will be even higher.

 

Instead of selling it, let's say you want to leave it to your kid.  To avoid probate, you decide to just give him a deed to the property as a gift.  For tax purposes, the gift transfers your basis to your kid.  Your kid's basis is $65,000 - the same as your basis.  If your kid sells for $300,000, it's the same result - a chunk is due Uncle Sam.

 

Rather than give the deed, let's say you hang onto to the property until death and your kid gets it through your will.  Section 1014 of the Internal Revenue Code (IRC) says the basis gets stepped-up to FMV on the date of your death.  Now, your kid's basis is $300,000.  If your kid sells, there is no gain and no tax.  Lovely!   

 

Lesson:  In many cases, it pays to hold onto property until death to get the step-up.  Don't just give property away without considering its cost basis and capital gains.

 

Tidbit:  IRC 2036 and IRC 1014(b)(9) lead to the same result if you give your kid a deed to the home and retain a life estate.  No probate, plus a step-up.

[Coytee]

Same holds true with Stocks....  so, rather than adding your kids onto your account as you get older "so they can take care of you", put them on there as a beneficiary via TOD designation (Transfer on Death) AND THEN also give them either trading authority or powers of attorney.  Now you're still set when you get older and the kids get the stepped up cost basis.

 

This doesn't apply to qualified accounts (IRA's) as everything out of a pretax qualified account is taxable upon distribution so there is no step up.

 

Oh, and when you sign any of these legal forms, you must make sure your pen is precisely 7.47832957 inches long 

 

[wuzzzer]

For real estate I thought if you owned a property for a few years and then sold it there aren't any capital gains?

[Jeff Matthews]

5 minutes ago, wuzzzer said:

For real estate I thought if you owned a property for a few years and then sold it there aren't any capital gains?

Only the home you live in.

[wuzzzer]

3 minutes ago, Jeff Matthews said:

Only the home you live in.

 

Missed the rental home part. 

[Jeff Matthews]

15 minutes ago, wuzzzer said:

 

Missed the rental home part. 

Yes.   Keep in mind it might be your homestead and exempt if you sell it.  But if you gift it to your kid before death, and it is not his homestead when he sells it, he'll owe Uncle Sam.

[Jeff Matthews]

29 minutes ago, Coytee said:

Same holds true with Stocks....  so, rather than adding your kids onto your account as you get older "so they can take care of you", put them on there as a beneficiary via TOD designation (Transfer on Death) AND THEN also give them either trading authority or powers of attorney.

Another good example.  Isn't it (not) funny how form changes substance?  

[Coytee]

1 hour ago, Jeff Matthews said:

Only the home you live in.

 

Doesn't it require that  your home is your primary residence for the prior two years?

 

So, if someone owned 5 rentals....  they could sell their "current" home, move into rental for 2 years, sell it and take exemption, move into next rental for 2 years, sell and so on??

 

 

[Coytee]

2 hours ago, Jeff Matthews said:

Instead of selling it, let's say you want to leave it to your kid.  To avoid probate, you decide to just give him a deed to the property as a gift.  For tax purposes, the gift transfers your basis to your kid.  Your kid's basis is $65,000 - the same as your basis.  If your kid sells for $300,000, it's the same result - a chunk is due Uncle Sam.

 

I think this is important and something many people screw up.

You "gift" them the residence....you "gift" them the shares of stock.....  in both cases, you are ALSO "gifting" them your original basis so there are no tax savings.

 

Best that they inherit the asset.  Yes, this means you had to die.

 

 

[BigStewMan]

I sold a rental property and paid a hefty capital gains tax.  I was told that to avoid the tax I had to purchase another rental within a certain time frame.  another property was not what I was interested in -- being a landlord is not my idea of fun.  I was also told that if I lived in it for something like two or three years then I could consider it my residence and no longer a rental ... that wasn't of any interest to me.  the house was 90 miles from my job and in Los Angeles Traffic that would have been a nightmare -- so I just paid the tax.