Dana Reid of Davis Wright Tremaine LLP writes about effectively utilizing your combined federal gift and estate tax exemption.
The article begins as follows:
As of 2016, each person has an aggregate $5.45 million exemption from the federal gift and estate taxes. This exemption can be used either during lifetime or at death (or both, if not all of it is used for lifetime gifts). When determining how best to make use of this exemption, make sure you consider – among other things – the federal income tax basis of any property you want to transfer during lifetime.
Specifically, consider the following tax rules: (1) the recipient of a gift takes the donor’s federal income tax basis in the gifted property (a “carry-over basis”), and (2) a surviving spouse receives property of the deceased spouse with a federal income tax basis equal to the fair market value the property at the time of the first spouse’s death (a “stepped-up basis” if the property has appreciated in value).
For example, 100 shares of stock with basis of $500,000 and fair market value of $5,000,000 have $4,500,000 of “built-in gain” that would be taxable when the shares are sold. If those shares are gifted to a child during the shareholder’s lifetime, the child retains the $500,000 basis (preserving the built-in gain of $4,500,000 that will be taxable on a later sale). But, if that same stock is worth $5,000,000 at the time of the shareholder’s death, the shareholder was married, and the shares were community property or the shareholder’s separate property (as opposed to the spouse’s separate property), and the shares pass to the surviving spouse as a result of the shareholder’s death, then the shareholder’s spouse takes those shares with a new federal income tax basis of $5,000,000 (all the built-in gain is eliminated). Further, if that surviving spouse then gifts the shares to that same child following the shareholder’s death, the child takes the shares with the $5,000,000 income tax basis – eliminating income taxation with regard to the $4,500,000 in former built-in gain on any subsequent sale.
Posted by Pooja Shivaprasad, Associate Editor, Wealth Strategies Journal