Like everything else connected with gift giving, the kind of property you choose to give away—for example, cash, stocks, or real estate—can have tax consequences for you and for the recipient.
You can give only what's yours. If you own property together with your spouse or someone else, you must both consent before you give it away. Especially in community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), it can be difficult for married people to know who owns what.
Learn more about making gifts that won't trigger federal gift tax.
Giving to Individuals: Avoid Appreciated Property
If you're trying to decide what you want to give away, look among your assets for property that you expect to go up in value. If you hold onto it until your death, your estate will be worth that much more, and probate fees (and estate taxes, if your estate is large enough) will be correspondingly higher.
When you give away property that's likely to appreciate, there's another benefit for the inheritor, as well: Someone who acquires an asset by inheritance gets a "stepped-up" tax basis for the asset. That can result in lower capital gains tax when the asset is eventually sold.
But when you give someone property during your lifetime, the recipient's tax basis—the amount from which taxable profit or loss is calculated if the property is ever sold—is the same as yours.
EXAMPLE: Years ago, Vinny paid $100,000 for a piece of land. That amount is his tax basis. Now he gives the land to his niece, Jackie; her tax basis is $100,000, too. If the land is actually worth $150,000 now, and Jackie turns around and sells it, she'll have to pay capital gains tax on her $50,000 gain.
If, on the other hand, you leave property at your death, a different rule applies. The recipient's tax basis is the fair market value of the property at the date of your death. In short, if the property has increased in value since you bought it, the recipient will get a higher basis—which translates into lower taxes down the line.
EXAMPLE: If Vinny's niece inherits the land from him, her tax basis will be the market value of the property at the time of his death—whether it's more or less than his basis. If the value is still $150,000 when Vinny dies, and Jackie sells the land for that amount, she'll have zero taxable gain. In other words, Vinny's gain is never taxed.
Obviously, how these rules should affect your actions depends on your particular situation. If you want to make a gift of appreciated property now and expect to live another 25 years, you won't want to postpone the transfer until your death just for some hypothetical income tax savings.
Even if you make taxable gifts now, and use up some of your personal estate tax exemption, it may be worth it. Remember that you don't have to actually pay federal gift and estate tax until you give away or leave more than the exemption amount, which for deaths in 2013 is $5.25 million per person, and $10.5 million for married couples.
Giving to Charities: Pick Appreciated Property
Different rules apply to charities, however. It's often a good idea to give away appreciated property to charities--you don't have to pay tax on the gain, and you get an income tax deduction for the current fair market value of the property.
EXAMPLE: Helen wants to give a large donation to a local food bank. She has several options:
- She could write a $10,000 check and claim an charitable tax deduction for that amount on her income tax return.
- She could sell some stock, which she bought for $6,000 many years ago and that has since doubled in value, and write a check from the proceeds. She would have to pay capital gains tax (currently 20%) on the gain.
- She could donate the shares of stock diectly to the charity.