“B” is for Basis and “C” is for Capital Gains Tax: Don’t Throw Money Away with Poor Planning

shutterstock_188080733In a world where estate tax only applies where an individual US person has over $11 million in assets (or $22 million for a married couple), the main focus of estate planning clients is often avoiding probate and the fees that come with it.  (Attorneys’ fees in a Florida probate case can be as high as three percent of the deceased person’s assets.)

Probate is the process of changing ownership from the deceased person to their heirs.  People often try to avoid probate by transferring assets to their children during life or naming their children as co-owners of assets during life.  Almost every week, we speak to a potential client who has named their children as co-owners of real estate, business interests and investment accounts.  While this strategy can help a person avoid probate, it is not always the best practice, as it ignores basis planning and capital gains tax ramifications.  In an attempt to avoid probate, a person can create tens of thousands, and even millions of dollars, in capital gains liability instead.

Tax basis represents an owner’s initial investment in an asset and taxes are usually assessed on the difference between the item’s fair market value or sale price and the item’s basis.  For example, if a stock is purchased for $5, and the share appreciates to $9, the owner’s basis is $5 and the owner will be taxed on the $4 of appreciation upon the sale of the stock.

When you gift something to someone during your life, the tax basis in the item is your basis.  An asset inherited upon a person’s death has the current fair market value as its basis.

For example, Mary is a widow and she specializes in real estate investments. Ten years ago, Mary bought a building for $1 million.  The building has appreciated to be worth $5 million ($4 million in appreciation).  If Mary gifts the building to her son Sam during her life, or names him as a joint owner, Sam’s basis in the property, even after Mary’s death, is $1 Million.  If Sam sells the building, he will pay capital gains tax on the $4 million of appreciation (up to $952,000). If Sam inherits the same property on Mary’s death, his basis is the current fair market value of $5 million and he pays zero capital gains tax upon sale.

This applies to most assets, including real property, investment accounts, and ownership interests in LLCs and Corporations.

The important question then is “Can I avoid my heirs paying unnecessary capital gains tax and also avoid the cost of probate?” The answer is YES.  In most situations, the majority of probate expenses and unnecessary capital gains taxes can be avoided by putting the property in a Revocable Trust during life.  During life, there are no changes in how the property is taxed and the person who creates the trust continues to use their social security number for all trust business.  Upon death, the property distributed to the deceased person’s heirs receives a new basis, which avoids huge exposure to capital gains tax and the costs and inconveniences of probate are avoided.  To speak to a knowledgeable Miami Estate Planning Attorney about Revocable Trusts, Basis Planning and Avoiding Capital Gains Tax, Call the law office of Lavender Greenberg at 786-832-4694. 

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