As I gaze outside at yet another major snowstorm here in Mercer County, NJ and contemplate how nice it would be if I were visiting my folks near my Boca Raton, Florida office, I am reminded of a tax savings idea that I heard was gaining traction amongst wealthy children whose parents are still living.
With the federal estate tax exemption up to $5,340,000 after its most recent adjustment for inflation, children that own highly appreciated assets (such as stock or real estate) can simply gift these assets to their parents now.
When the parent passes away, the children can receive these assets back with a stepped up basis, potentially saving hundred of thousands of dollars in capital gains taxes when the assets are finally sold.
While at first blush this seems like an incredibly easy strategy to save money on taxes, there are actually many pitfalls. In particular, the strategy will not work well if:
- the parent is receiving Medicaid or government benefits;
- the parent lives in a state or jurisdiction that has a state estate tax or inheritance tax;
- the parent has remarried;
- the parent has significant wealth and has their own estate tax problems; or
- MOST IMPORTANTLY, the gift must be made to the parents at least one year prior to the parent’s death to avoid triggering Section 1014(e) of the Internal Revenue Code.*
Additionally, there could be problems if you have siblings or step siblings as the child who originally owned the assets would obviously want to ensure their return. Here is the final catch, the IRS will not like it if you prearrange this plan. In other words, the parent can’t immediately promise/guarantee that they will redirect the asset to the child.
Finally, gifts of certain assets will require an appraisal for the federal gift tax return that would be required (Form 709), potentially making this a costly transaction.
*Updated on 5/22/14 to reflect the need to make the gift at least one year prior to parent’s death.