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Capital gains and the estate tax

In the process of beginning to create an estate plan a lot of people have probably heard that it is best to give away a substantial portion of one’s wealth before they are gone in order to minimize tax liability and to make sure that gifts go to the people and organizations that they are intended for. This can be a very good method for pre-emptively managing an estate, but in some circumstances might not be the best possible option.

For example, recent tax code updates have created a situation in which it may be more advantageous to transfer certain types of assets at death, such as those which would be subject to a capital gains tax.

Capital gains tax is evaluated when an asset is sold and the tax is paid on the difference between the purchase price and the sale price. When someone gives a gift that is subject to capital gains tax during life, the person who receives it also inherits the purchase date and price and will eventually pay taxes on the difference as though they were the purchaser. However, if that same asset is passed upon the death of the purchaser, then the purchase price is replaced by the value on the date of the person’s death. This means that the recipient could sell it right away and not pay any capital gains tax if the value had not changed, or sell the asset later and pay taxes only on the amount of increase during the time they possessed it.

Using this plan, the assets would be a part of the estate and therefore would be subject to the estate tax if the total value of the estate exceeds the exemption (currently set at $5.34 million for individuals). Assets above and beyond that exemption level can be taxed at a very high rate – up to 40 percent at its highest levels. This is why many people attempt to move assets out of the estate preemptively, paying other types of taxes at lower rates.

Of course, the above explanation is only the tip of the iceberg as far as estate and tax planning goes, so there are many more subtleties that could impact the situation, so it is best to consult directly with an estate tax planning specialist to find out more.

Source: Forbes, “Freebasing Your Estate,” Deborah L. Jacobs, Feb. 12, 2014. 

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