How Do I Reduce Size of My Taxable Estate?

The current lifetime estate and gift tax exemption will be cut by half after 2025 unless Congress acts to extend it, which doesn’t seem likely in the current financial environment. You may want to consider options to reduce the size of a taxable estate. There are steps to minimizing not only estate and gift taxes but also income and capital gains taxes, as reported in a recent article, “Smarter Ways To Make Estate Planning Gifts,” from Forbes.

It’s generally better to give property than cash, especially investment property. Recipients are less likely to sell these gifts and spend the proceeds. It’s more likely that money will be spent rather than invested for the long term. Investment property is almost always a better gift for the long term.

However, property gifts come with potential taxes. To minimize the after-tax wealth, make gifts of the correct properties. There are a few principles to follow.

Don’t give investment property with paper losses

When reducing the size of a taxable estate, avoid giving investment property with paper losses. The recipient of a gift of property gets the same tax basis in the property as the person making the gift. The appreciation during the holding period is taxed when the gift recipient sells the property.

If the property didn’t appreciate when the owner had it, the beneficiary’s tax basis would be lower than the owner’s basis and the current market value. When the investment loses value, the beneficiary reduces the basis to the current fair market value. The loss incurred by the owner won’t be deductible by anyone. There is no winner here. The owner should hold or sell the lost property to deduct the loss and gift the after-tax proceeds.

Give appreciated investment property after a price decline

If you are looking to reduce the size of a taxable estate, give appreciated investment property after a price decline. You can give more stock or mutual fund shares by making the gift when prices are lower. This maximizes the annual gift tax exclusion and minimizes the use of the giver’s lifetime estate and gift tax exemption.

Let’s say shares of a mutual fund were at $60—you could give 266.67 shares tax-free under the annual gift tax exclusion ($17,000 in 2023). If the price dropped to $50, you could provide 320 shares without exceeding the exclusion limit.

When the recipient holds the shares and the price recovers, they will have received more long-term wealth. The giver would not have incurred estate and gift taxes or used part of their lifetime exemption.

This is also why families should consider gift-giving throughout the year, not just at year’s end. An even better way: determine how much you intend to give early in the year, and then look for a good time to maximize the gift’s tax-free value.

It’s good to give property most likely to gain in value

When reducing a taxable estate, give property most likely to gain in value. Suppose the goal is to remove future appreciation from the estate or gift property you expect to appreciate. This also maximizes the wealth of loved ones, especially enjoyed when the beneficiary is in a lower tax bracket. When the property is eventually sold, the beneficiary will likely pay capital gains taxes on the appreciation at a lower rate than the giver. You pass on more after-tax wealth and reduce the family’s overall taxes.

Retain property if it has appreciated significantly

When it’s time to sell the property, and the loved one is in the 0% capital gains tax bracket, it’s best to gift the property and let them sell it. Even if the loved one is in the 10% capital gains tax bracket, this still makes sense if you’re in the higher capital gains tax bracket. But there are some things to consider. It won’t be a welcome gift if the gain pushes the recipient into a higher tax bracket and triggers higher taxes on all their income. If there’s no urgent need to sell the property, you can ensure a 0% capital gain by simply holding onto the investment.

Give income-generating assets

If you hold income-generating investments and you don’t need the income, consider giving those to family members in a lower tax bracket. This reduces taxes on the income, and the recipient is less likely to sell the asset to raise cash when it’s generational.

Remember the Kiddie Tax

Heirs aged 19 or under (or under 24 if they are full-time college students) are hit with their parents’ highest tax rate on investment income they earn above a certain amount, which was $2,300 in 2022. At this point, gifts of the income-producing property create tax liabilities, not benefits.

If you have questions, then you should contact a qualified Austin estate planning attorney. You could Book a Call, and we can get started making a plan to help you achieve your Life and Legacy goals.

Reference: Forbes (Dec. 27, 2022) “Smarter Ways To Make Estate Planning Gifts”