When planning for the future, it’s important to think about how you want to pass on your belongings, like your house, car, or savings. Deciding when to transfer these assets—before or after you pass away—can make a big difference in the amount of taxes your loved ones might have to pay. Let’s explore how each option affects taxes so you can make the best choice for your family.
Giving Away Property Before You Die: The Gift Tax and Capital Gains
If you decide to give your house or other property to someone while you’re still alive, it’s considered a “gift.” This might sound straightforward, but there are tax rules to consider. For instance, the IRS has a gift tax, which kicks in if you give more than $17,000 worth of property to someone in a single year (as of 2024).
But here’s where it gets tricky: capital gains tax. Let’s say you bought a house for $200,000 a long time ago, and now it’s worth $1 million. If you gift this house to your child, they inherit your original purchase price, which is $200,000. If they decide to sell the house for $1 million, they would have to pay capital gains tax on the difference—$800,000. That’s a huge tax bill!
Passing Property After You Die: The Step-Up in Basis Advantage
Now, let’s say you don’t give away the house before you die, but instead, it gets passed on to your child through your will or estate. Here’s where the tax rules are more favorable: the step-up in basis. When your child inherits the house after your death, the “basis” for tax purposes is “stepped up” to the current market value of the property, which is $1 million.
If they sell the house for $1 million right after they inherit it, there’s no gain—meaning no capital gains tax. This could save your child a massive amount of money in taxes compared to gifting it while you’re alive.
A Simple Example
Imagine this scenario: You have a house you bought for $200,000, and it’s now worth $1 million.
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If you gift the house now: Your child inherits your original purchase price ($200,000). If they sell it for $1 million, they owe taxes on $800,000 of profit.
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If your child inherits the house after you die: Their basis is the current market value ($1 million). If they sell it for $1 million, they owe no taxes because there’s no gain.
Consider Estate Taxes, Too
There’s another layer to think about if you have a very large estate. The federal estate tax exemption is $12.92 million per person (as of 2024). This means if the total value of everything you own is under this amount, your heirs won’t owe estate taxes. If your estate is over that amount, though, anything above could be taxed at up to 40%. Some states also have their own estate or inheritance taxes, which could come into play.
Key Points to Remember
- Gifting Before Death: Could mean gift taxes and big capital gains taxes for the person receiving the property.
- Inheriting After Death: Benefits from a step-up in basis, usually leading to no capital gains tax if the property is sold right away.
- Estate Taxes: Only a concern for very large estates, but still something to think about in your planning.
Conclusion
Deciding when to transfer your property is more than just a personal choice; it’s a financial decision that can have significant tax implications. By understanding the difference between giving away property now or letting your heirs inherit it, you can make smarter decisions that protect your family’s financial future. And remember, it’s always a good idea to talk with a tax professional or estate planner to make sure you’re making the best choice for your situation. After all, the goal is to leave behind more than just memories—preferably, without a surprise tax bill attached.