**The example below is a hypothetical illustration based on composite, real-life situations and does not describe an actual client. Names, amounts, and circumstances have been changed for illustrative purposes. Results will vary based on individual circumstances.
A Gift Today Can Have Tax Consequences Tomorrow
When transferring wealth to the next generation, the total value of the gift is only part of the conversation. The asset that seems most logical to give today may not provide the most favorable tax outcome for the family over the long term. Having an informed wealth transfer strategy requires balancing multiple moving parts, including cost basis, untaxed growth, timing, and your child’s future financial needs.
The Gift’s Tax Liability
In a situation we encountered, a $500,000 investment account was transferred from a mother to her daughter as a lifetime gift. While the transfer itself went smoothly, it came with a significant hidden condition: the daughter also assumed her mother’s original purchase price—known as the cost basis—of $150,000. Because of this, the account carries $350,000 in built-in, untaxed growth. If the daughter decides to liquidate these investments, that $350,000 difference could be subject to capital gains tax, depending on current tax laws and her individual income bracket. This tax exposure is also dynamic; if the account grows to $700,000 while the benchmark remains $150,000, the taxable growth rises to $550,000. Ultimately, the total market value of an account can differ significantly from its actual after-tax value.
Timing & Tax Basis
The timing of a transfer completely changes how the IRS treats the asset’s purchase price. Choosing between a lifetime gift and an inheritance determines which type of tax basis applies:
- Gifted Assets (Carryover Basis): When you give an asset to a child during your lifetime, they receive a carryover basis. They inherit your original purchase price. If the asset has grown significantly, they also inherit the future tax liability attached to that growth.
- Inherited Assets (Step-Up in Basis): Assets passed down after death generally receive a step-up in basis. The tax benchmark resets to the fair market value on the date of death. Using the example above, if the child inherits the account valued at $500,000 and sells it for $500,000, there would generally be little or no capital gains tax owed on the growth that occurred during the parent’s lifetime.
What does your child need now vs. later?
A gift today can have tax consequences tomorrow. Understanding the potential impact of different assets and strategies can help families make more informed decisions about transferring wealth. It can be important to consider:
- What does your child need now versus later?
- Which assets are most appreciated?
- What are the potential tax consequences for both generations?
- Could additional income affect the child’s AGI or tax credits?
- How might gifting an asset compare with passing it through an inheritance?
Create a Strategic Plan
Are you creating a plan to gift strategically or transfer wealth? Let us help. We’re here to walk you through the process, keep you updated on all potential tax benefits, and help maximize what you gift or leave behind.
Have questions? Or interested in meeting with our Storen Advisory team? Click here to contact us now. Or click here to learn more about our Financial Planning Investment Services.
Blog by Kiran Sharma – Partner, Wealth Advisor
Learn more about Kiran and the rest of the Storen Financial team here.