Upstream Tax Planning
For most Americans, estate planning involves determining how to transfer your accumulated wealth to the younger generation, either through annual gifts or through your estate (or living trust if you want to avoid probate). But some tax professionals are recommending that some of their clients gift assets to their parents.
What? The point of the exercise involves what’s called the step-up in basis, a fancy term for removing capital gains tax obligations from an asset that has grown in value.
If you sell an asset for more than you paid, you owe taxes on the difference—right? If you owned the (stock, mutual fund, etc.) for more than a year, then you will pay at the capital gains rate; otherwise the gain is taxed at your tax rate, as ordinary income.
But (here’s the key) if you die owning the asset, and it passes on to your heirs, then they receive the (stock, mutual fund, etc.) at the current market price—and presto! If they sell it tomorrow, there’s no gain to report, and no tax obligation. The ‘step-up’ is the fact that the low purchase price is now reset to the current market value, making the taxable capital gains evaporate.
With the ongoing bull market, many people are holding assets that are worth more than they paid for them, so this step-up at death can be a valuable part of estate planning. Tax professionals recommend that, if the gains are extraordinary and you don’t need the money, then it’s beneficial to keep the extremely profitable investment until you die and give a nice tax break to your heirs.
But what if you gift that profitable investment to your parents, who are probably closer to death than you are? They receive it, and when they die, they pass it back on to you as the heir—with the step-up in basis. You can then sell that holding with no capital gains obligation.
Of course, this can get complicated. If you’re just one of several of your parents’ heirs, it’s possible that the stock you gift ‘upstream’ will get passed on to someone else. But your parents can write the will such that this won’t happen. And the parents could even leave the appreciated asset to your children instead of you, bypassing a generation.
There’s one catch; your parents would need to live for at least three years after you gift the asset to them. Otherwise, the asset reverts back to you. This is not a ‘deathbed planning’ opportunity. And it’s also probably not worth doing if there’s only a modest gain in your assets. But you might want to check; did you happen to buy Apple or Nvidia stock ten or so years ago?
