“There is a way to do it better-find it.” – Thomas A. Edison
Many people spend way too much time trying to predict the market. If they paid attention to the rules to reduce taxes, they could save 15% or more.
Capital gains management — Maximizing stepped-up tax basis in assets for married couples
An “unrealized gain” describes the situation in which an investment (e.g. stock, real estate, etc.) increases in value, but isn’t sold. For example, you bought XYZ for $10 and it is now $20 — if you’re still holding it, you have an unrealized gain of $10. Obviously, you do not pay taxes on an unrealized gain. Once the investment property is sold, the unrealized gain becomes a realized gain and is subject to capital gains tax.
Let’s add to the example – let’s say you die while still owning the XYZ stock with the $10 unrealized gain. When ownership of that asset is then transferred to an estate beneficiary, that beneficiary’s tax basis in the asset is the value of the asset on the date of your death. This is called “stepped-up basis.” Therefore, for the beneficiary with a stepped-up tax basis who then sells the XYZ stock for $20, there is no gain. To put it even more plainly, if you sell XYZ for $20 before your death, you are taxed on the $10 gain, but if your beneficiary sells XYZ for $20 after your death, there is no gain and, therefore, no tax. Typically, the stepped-up tax basis is the value on the date of your death, but a beneficiary has the option of choosing the value exactly 9 months after your death.
As you might expect, upon death, there could be a step-up or a step-down in tax basis. In other words, if you have an unrealized loss at the time of your death, your beneficiary will have a lower tax basis. This would be a disadvantage.
How might a married couple take advantage of these rules?
Most states are common law states. South Carolina, Georgia, and North Carolina (and many others) are common-law states. In these states, if an asset is owned by husband and wife with a “right of survivorship” or as “tenants by the entirety,” the surviving spouse gets a step-up or step-down in basis on the deceased spouse’s 50% interest in the asset.
With these things in mind, couples in common law states sometimes hold assets in the name of the older spouse based on the presumption the older spouse will die first and the younger (surviving) spouse will have a stepped-up tax basis in the asset. The only limitation on this strategy is the requirement that the older spouse own the asset at least one full year prior to death. This is called the “boomerang” rule.
In contrast, in community property states (ex. Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin) the surviving spouse gets a step up whether the asset is owned individually or jointly. In these states, each spouse is viewed as having a 100% ownership interest in an asset at all times regardless of how the asset is titled. Upon the death of the surviving spouse, it is possible the children will have the benefit of a double step-up in tax basis. One step-up after the death of each parent.
For further information: The Kitces Report Volume 3, 2018 http://www.kitces.com Page 6 of 24
Property held in certain kinds of trusts is not eligible for a step-up in tax basis, but a trust can serve purposes greater than maximizing the tax benefits of stepped-up basis strategies.
If a deceased spouse has experienced a loss in the sale of any asset in the year of his/her death, the surviving spouse should consider selling an asset with a gain in the same year. By doing this, the tax on the capital gain realized from the sale will be offset by the loss – in other words, the tax burden is reduced or eliminated.
To recap:
- Consider transferring assets with unrealized gains into the name of the older spouse (or perhaps a spouse who is ill). Remember, in order to be eligible for a step-up in basis, the asset must be owned by that spouse for at least one year prior to death.
- Consider moving assets with unrealized losses into the name of the younger/healthy spouse.
- If the deceased spouse has experienced a loss in the year of death, the surviving spouse should consider selling an asset with a gain.
Coordinating strategic ownership of assets can be complicated. Feel free to ask us any questions or click here to set up a phone appointment. Happy to help.
On the lighter side, little moments can be special moments. I was walking alone this past weekend. Saw a guy riding his bike with his dog running beside him. Looked like they were trying to see how fast they could both go. They were moving quickly. Both were smiling – so was I.
Hope all is well with you and your family,
Jeremy
Finger Financial Five – 5 points in 5 minutes or less – is to provide you with a weekly shot of useful financial information. My intention is to share principles, so that you will have more clarity and peace, that help you make better financial decisions.
Investment advice offered through Stratos Wealth Advisors, LLC, a registered investment advisor; DBA Riverbend Wealth Management.
This content is developed from sources believed to be providing accurate information and provided by Riverbend Wealth Management. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stratos Wealth Partners and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
