Thinking About Gifting to Your Children?

This week Angela discusses the complexities and risks involved in gifting significant assets to children, such as land or businesses. She emphasizes the importance of proper planning and professional advice to avoid costly tax consequences and unintended liabilities. The episode focuses particularly on the tax implications of gifting versus inheriting assets and the importance of understanding cost basis.

Key Takeaways 💡

• Many parents consider gifting significant assets like land, money, or business interests to their children as they age, but often do so without seeking comprehensive advice, which can lead to costly mistakes. Even when advice is sought, it is frequently from professionals who may not have a holistic understanding of estate and tax planning, resulting in overlooked risks.
• Gifting assets without proper planning can expose the family to various risks including lawsuits, creditor claims, divorce risks affecting gifted assets, business liabilities of the recipient, and strained family relationships. Additionally, gifting can unintentionally disinherit grandchildren or transfer assets to unintended parties, such as a new spouse of a child’s widow(er).
• One of the most significant and common financial pitfalls of gifting assets is the increase in taxes, particularly due to the transfer of the original cost basis to the recipient. When a gifted asset is sold, the recipient pays capital gains tax based on the original purchase price, which can be much higher than if the asset was inherited.
• Cost basis is the original value of an asset for tax purposes, usually the purchase price minus any depreciation taken. When an asset is gifted, the recipient inherits the donor’s cost basis, meaning they may face large capital gains taxes upon sale. In contrast, if the asset is inherited after the donor’s death, the cost basis is stepped up to the asset’s fair market value at the time of death, potentially eliminating capital gains tax if sold immediately.
• This difference in cost basis treatment between gifting and inheritance can result in significant tax savings if assets are held until death rather than gifted during life. For example, land purchased decades ago often has a very low cost basis compared to its current market value, so gifting it can trigger large capital gains taxes for the recipient upon sale.
• Even if the family does not plan to sell the gifted assets, the cost basis remains important for other reasons, such as depreciation recapture on inherited rental properties or equipment. Inherited assets receive a stepped-up basis, allowing heirs to depreciate the asset anew, which can provide substantial income tax savings over time.
• Farmers and ranchers may not realize they can depreciate certain components of their land, such as nutrients, which can offer additional tax benefits. This is an often-overlooked opportunity that can improve cash flow and reduce tax burdens across generations.
• Angela stresses the importance of not making gifting decisions alone or without thorough professional guidance. While gifting can be beneficial in some cases, it must be done strategically to avoid unintended tax consequences and other risks. There are creative planning strategies available to mitigate these issues, especially in states like Texas.
• The podcast concludes with a reminder that tax laws are complex and constantly changing, and that even accountants and tax professionals may not have complete knowledge of all relevant details. Therefore, a holistic life planning approach involving multiple professionals is essential to protect family wealth and minimize tax liabilities.