With the meltdown and continued volatility in the financial markets comes a potentially favorable wealth transfer tax strategy. Lifetime gifts of stock and securities at depressed market values can transfer future appreciation out of your estate and to lower generations as the securities recover their value.
For 2008, an individual may transfer $12,000 transfer and generation-skipping tax-free to an unlimited number of individuals. A married couple may transfer $24,000 without regard to which spouse’s name is on the securities. For example, a couple with four children and six grandchildren may transfer $240,000 at current market values to their family. Doing so moves all future appreciation, including a market recovery in this value, to future generations. These transfers will be free of any transfer tax and will not require filing a gift tax return.
For 2009, the amounts increase to $13,000 per individual and $26,000 for a couple. Therefore, the same family may transfer an additional $260,000 of depressed securities to lower generation family members in January. The couple will then have moved $500,000 at current market value, and all future appreciation, out of their estates in a period of just over 45 days with no tax consequences.
Keep in mind that the income on these securities, interest or dividends for example, earned by a child who has not attained age 18 by the end of the tax year will generally be taxed at the child’s parents highest marginal tax rate. This does not include capital gains, however, when the securities are sold.
These gifts are not a slam-dunk decision, however. It is necessary to consider how capital gains will be taxed when the securities appreciate and are subsequently sold.
Generally, a donor’s tax basis in gifted property carries over to the donee. Under this general rule, for example, if a couple transfers’ securities having a market value of $125,000 and a tax basis of $100,000 to a child, the child’s tax basis in those securities is also $100,000. A subsequent sale of the securities at $125,000 results in a $25,000 capital gain that is taxed to the child. If the parents have held the stock for at least one year, the gain will be long-term capital gain to the child, even if sold immediately. In other words, the parents’ holding period of the securities "tacks" to the holding period of the child. That’s the general rule for appreciated property; special "dual basis" rules apply to gifts of property when the fair market value is less than the donor’s basis. This “dual basis” should give some pause in planning gifts of depreciated property.
Under the dual basis rule, the donee’s basis for determining loss in depreciated property is the lesser of the donor’s basis or fair market value on the date of the gift if the property is subsequently sold at a value less than the donor’s basis on the date of sale. Assume that a couple transfers securities having a market value of $90,000 and a tax basis of $100,000 to a child. The child subsequently sells the securities at their $90,000 fair market value. In this case, the child recognizes no gain or loss; the child’s basis is $90,000, and $10,000 of the parents’ basis has fallen through the cracks. In a like manner, assume the value of the securities continues to decline and are sold for $50,000. The child has a capital loss of $40,000 ($50,000 sales price less $90,000 basis) and, again, $10,000 of the parent’s basis has disappeared.
Assume, however, that the value of the securities fully recovers and continues to appreciate to a value of $150,000 at the time the child sells them. Here, the value is greater than the parents’ basis resulting in real gain. Now the child’s basis for determining taxable gain is the same $100,000 as it was in the hands of her parents and the child recognizes a gain of only $50,000.
The bottom line is that there are several considerations in gifting depreciated property. If you expect that the property will fully recover its value and continue to appreciate over the long-term, a gift now of securities at depressed value makes a lot of sense from the standpoint of estate tax planning. If you believe that the securities will recover some value before being sold, but not up to the level of the donor’s basis, you may need to consider the loss in basis that might occur. It may be more appropriate to sell the securities yourself, recognize the full loss, gift the cash proceeds to the child, and have the child reinvest the cash. I recommend the child postpone reinvestment in the same or substantially similar securities for 30 days to avoid possible application of the "wash sale" rule and the parents’ loss disallowed.
If you have specific questions concerning estate planning, please contact me at response@phdcpa.com or call me at 214.957.3366.
Ronnie
© 2008 Ronnie C. McClure, PhD, CPA
