When it comes to gifting money to children or loved ones, many individuals are hesitant to do so for a variety of reasons, including:
- Fearing the loss of control over assets
- Feeling that their children or grandchildren are not mature enough to handle gifts made to them
- Not wanting to “spoil” their children or have them become “entitled”
- Being unsure of how to plan the distribution of those gifts
Developing a gifting strategy that addresses what, how much and when to give can often feel overwhelming. Read on to learn more about the pros and cons of gifting to family members — including gifting stock, property and cash — and which financial factors to consider before you make a gift.
Advisors will often talk about gifting in the context of saving taxes and transferring wealth from one generation to the next. While these are core components to any gifting strategy, it’s important to first understand why you want to make a gift at all. This may seem like an obvious question, but when you dive deeper to understand your motivations, it helps to align your values and clarifies what is most important in making gifts. It also becomes the guiding principal for developing your gifting strategy. For example, you may want to:
- Help a family member who lost a job or had a health issue and needs immediate assistance
- Help your elderly parents with the cost of ongoing housing and care
- Assist your children with buying their first home
- Set up a legacy education fund to ensure that your children and grandchildren will have the funds available for education expenses
- Transfer a family business to the next generation
- Improve the financial well-being of loved ones beyond your lifetime
The more you understand your own motivations, the more intentional you can be about making your gifts, communicating this with your loved ones and setting realistic expectations. Regardless of the reason or motivation for making a gift, there are a core set of rules and exclusions you should keep in mind when contemplating a gift. Learn more about the annual gift tax exclusions available to you and your family in our article Annual Exclusion Gifts: A Simple Way to Transfer Wealth.
The first step in the gifting process is to understand cost basis and how it differs depending on the type of asset you’re gifting. So what is cost basis? Simply put, it’s the original cost of an asset plus any adjustments needed for depreciation, dividends and other fluctuations. It may also be referred to as “tax basis.” Generally, when you make a gift of appreciated property to a donee, knowing your cost basis is important.
The cost basis of property (land, residence, etc.) is the price originally paid for the property, plus improvements. When gifting property to family, the cost basis would be calculated the same as for a stock, unless improvements were made to the property after it was originally purchased.
Please note that when a donor makes a gift, they make a gift of their original cost basis to the donee. Alternatively, if a donor made a bequest through their will to a beneficiary, the beneficiary would receive a step-up in cost basis of the asset(s) bequeathed as of the donor’s date of death.
When a gift of property is made, your cost basis carries over to the donee and the assets will not receive a step-up in basis as they would if the assets had transferred to your beneficiaries upon your death. Knowing your basis is also important in determining how gain or loss is calculated for the donee if and when they eventually sell the property.
When you gift property with a built-in loss, the donee will have dual basis in the gifted property (instead of a carry-over basis). The donee’s basis for gain determination would be the donor’s basis. The donee’s basis for the purposes of calculating a loss would be the fair market value of the property on the date of the gift. In case the donee sells the property for a value that’s in between the donor’s adjusted basis and the fair market value on the date of the gift, there is no gain or loss. This simply means that the capital loss would forever be lost. Instead of gifting property that currently has an unrealized loss, consider selling the property yourself to claim the loss and then gift the cash proceeds.
The cost basis of stock is what was originally paid for the stock. To illustrate: If the donor paid $1,000 for a stock, which then appreciated to $15,000 before it was gifted to the donee, the cost basis of the gift would $1,000. When gifting stock to a child or family member, make sure you’re considering the cost basis rather than the current value.
The cost basis of cash is the value of the cash when gifted. To illustrate: If the person making the gift (the donor) gifts $15,000 cash to the person receiving the gift (the donee), the cost basis of the gift would be $15,000.
Another thing to keep in mind when gifting stock or property to family members is that there are rules that apply to gifts of depreciated capital assets:
- If the market value of the gift is less than the donor’s cost basis, the donee must use the donor’s cost basis for determining any future capital gains, not the gifted value of the asset.
- If the asset is sold by the donee for less than the gifted value, the capital loss is the difference between the gift value and the sales price, not the donor’s cost basis.
If the stock is sold for an amount between the gifted value and the donor’s cost basis, there is neither a gain nor a loss.
Other ways to gift to family members
There are a few other ways to gift to family members without dipping into your lifetime gift and estate tax exemption. Any amounts paid toward an individual’s medical or education expenses are not subject to the gift tax limits. For you to be able to enjoy this exception, you must pay directly to the provider of those services, i.e., make a check payable directly to the hospital for qualified medical expenses or to a college for tuition.
Another gifting technique relates to funding a 529 college savings plan. You are allowed to make a five-year accelerated gift into a beneficiary’s 529 plan by utilizing five years’ worth of your annual gift tax exclusion. As a result, you can gift up to $75,000 to each beneficiary’s 529 plan today even though it’s technically considered made ratably over five years. This allows you to begin enjoying tax-deferred and potentially tax-free growth on those assets. If you outlive the five-year term, the entire gift is excluded from your estate.
Gifting to family members, whether they be children, grandchildren or even siblings, involves important decisions about which types of assets to gift and the tax considerations of doing so. Before making gifts to family members, please consult with your attorney, accountant or financial advisor so that the gift is made in the best possible manner to suit your goals and objectives.
Matthew Babrick is a Senior Managing Director and Wealth Manager to First Republic Investment Management. He has over 15 years of experience working with families and foundations to help achieve their financial goals.