Tax Planning with Appreciated Assets

by | Feb 4, 2020

Question:        I own a stock portfolio which has appreciated significantly in value over the years. Can I transfer the portfolio to my aged mother and have her transfer it back to me upon her death so I can benefit from a step-up in basis when she dies?

Answer:           Generally speaking, this strategy will work. However, if you transfer assets you own to your mother, she dies within one year of receiving the gift from you and the assets are retransferred to you upon her death, there will be no basis adjustment for you.  The Internal Revenue Code specifically prohibits a taxpayer from receiving a new tax basis equal to the fair market value of assets which are returned to the taxpayer under these circumstances.  The so-called “step-up in basis” will be allowed in this situation if the decedent dies more than one year after the receipt of the gift.  Of course, if the time of the death is uncertain, then nothing may be lost in embarking on this strategy as  an unsuccessful attempt to achieve a step-up in basis  is simply that you will be in the same position as if you had not gifted your portfolio investments.

The Internal Revenue Code provides that a taxpayer’s assets will receive a new tax basis upon death equal to the fair market value of such assets.  For assets which have appreciated in value, this can result in a decreased tax if the assets are sold after the decedent dies.  Consider a taxpayer who bought shares of Microsoft for $10,000 which are now worth $15,000.  If the stock is sold before the taxpayer dies, the taxpayer will pay capital gain taxes on the $5,000 of appreciation in the Microsoft shares when the securities are sold.  If instead the taxpayer retains the Microsoft stock until death and the shares are worth $15,000 at that time, the recipient of the stock under the decedent’s Will or Trust will receive a new tax basis of $15,000. This means that the $5,000 of stock appreciation which occurred prior to the taxpayer’s death will not be subject to income tax and capital gains taxes will only be imposed to the extent the sale price of the Microsoft stock exceeds the new tax basis of $15,000. The step-up in basis often results in meaningful income tax savings for family members of decedents holding assets which have appreciated in value. If, on the other hand, shares have decreased in value since purchase, a decedent’s death will result in a decreased tax basis for the recipients. In this scenario, a sale before death is more advantageous.  

The prohibition on basis step-up can be avoided in other circumstances.  Instead of your mother bequeathing assets to you, the stock portfolio can be left to non-spouse family members such as your children who will then be entitled to a step-up in basis for the assets received.  However, the same prohibition on basis step-up will apply if you transfer the stock portfolio you own to your mother, she dies within one year of the transfer and the portfolio is transferred to your spouse upon your mother’s death.

The benefits of a basis step-up come into play in other circumstances as well.  Aged taxpayers often hold highly appreciated assets.  A lifetime sale of these assets results in a taxable gain which a taxpayer must report and pay tax on.  A more viable strategy of holding appreciated assets is to retain appreciated assets until death which will provide the family with an increase in tax basis, thereby reducing or eliminating capital gains taxes upon sale.  Taxpayers with appreciated real estate properties, for example, often retain these assets until death for this very reason. Where funds are needed, other cash-generating techniques can be employed. Cash can often be raised without a sale such as a cash-out refinancing in the case of an appreciated real estate property or a margin loan in the case of an appreciated stock portfolio.

No doubt family and economic concerns are paramount in situations such as these.  Not everyone can focus on tax considerations when faced with the challenges of an aging family member.  In the right circumstances, however, tax planning with appreciated assets can yield significant tax savings.

 

The Tax Corner addresses various tax, estate, asset protection and other business matters.  Should you have any questions regarding the subject matter or if you have questions you want answered, you may contact Bruce at (312) 648-2300 or send an e-mail to Bruce Bell.