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When is Making a Gift Advantageous?

Published 4/2/2018

Gifts may be made as part of an estate plan for a number of reasons. Some people gift property during lifetime to remove it from their estate, both to avoid probate and to reduce potential federal and/or state estate tax. Others gift property to transfer the income tax on income generated by the property to the donee, and still others transfer property in order to protect it from potential nursing home costs or other medical expenses. Prior to making gifts, all of the consequences of the gift should be carefully weighed. Otherwise, generosity now may actually cost beneficiaries many dollars in tax which would not otherwise be required to be paid. Additionally, the effect of the gift on the client's financial security should be considered.

Gifts which are made simply because the client wants to make a gift are not a question here. This discussion will be limited to gifts which are contemplated for one or more of the estate planning purposes mentioned in the previous paragraph. Gifting can be a valuable tool in estate planning, but often property is transferred without considering all of the effects of the gift. Therefore, in order to illustrate some of the pitfalls, we will discuss four problem areas which can be caused by gifting.

Loss of Control Over Assets

Parents sometimes name a child as a joint tenant on property in order to avoid probate. However, keep in mind that, if another person is named as joint tenant, the creditors of each of the joint tenants may legally reach the asset. Additionally, if the joint tenancy reads "or" between the names of the joint tenants, any joint tenant may go in and totally wipe out the account. If "and" is used, if the client wants to sell or mortgage the property or wants to withdraw funds if the property is a bank or brokerage account, all joint tenants must sign documents showing their approval of the client's actions.

Does the Gift Achieve the Desired End Result?

Many people name one child as joint tenant or put one child's name on an asset, with the understanding that, upon the parent's death, the child named as joint tenant, owner, or beneficiary will, in turn, distribute property to brothers and sisters to accomplish equal distribution. This plan can backfire in several ways. First, legally, the child named as joint tenant, beneficiary, or owner is the sole beneficiary and has no legal responsibility to include others in the inheritance. Even if the named child is totally trustworthy and will carry out the client's wishes, problems may be created using this method. While the child is the sole owner, prior to dividing the property with other family members, the property is open to collection by that sole owner's creditors. A car accident, divorce, or other unforeseen circumstances at this time may cause severe complications. Additionally, extra paperwork will be required to legally transfer some of the assets to the other family members. The child who was named as joint tenant or sole owner legally owns the asset until paperwork is completed to transfer assets to other family members, and those transfers are considered gifts from one child to the others. Depending upon the value of assets transferred, gift tax returns may be required to report these transfers.

Income Tax Considerations

Individuals qualify for exclusions from income tax on the sale of their personal residence on up to $250,000, provided specific requirements are met. However, if a person who is not the spouse is named as a joint tenant, or if the residence is put in someone else's name, the exclusion on sale of a personal residence will be affected. Specific effect on this exemption depends on details of ownership. Homestead credit may also be lost.

If property has increased in value over the years (such as the shares of common stock or the farm which was purchased many years ago), allowing beneficiaries to inherit the property rather than giving it to them now may be much more advantageous to the beneficiaries. If property is inherited, the beneficiary receives the fair market value of the property as the tax basis. For example, if Duane owns an asset which has grown in value over the years and can hold the asset throughout his lifetime, he will actually save his son, Jerry, tax dollars by not giving the asset to him now. If Duane purchased the asset for $5,000 and it's now worth $25,000, if Duane sells it for $25,000, he will pay any capital gain tax due on the $20,000 gain. If he gives the asset to Jerry and Jerry sells it for $25,000, Jerry will pay any tax due on the $20,000 gain. However, if Jerry inherits the asset, he also inherits as a tax basis the fair market value of the property on the date of Duane's death. If Jerry sells it for $25,000, he will owe no income tax.

Waiting Periods May Apply for Medicaid Purposes

Waiting periods may apply after gifts are made, which can cause some potential problems. If property is gifted and then nursing home care is needed, the person who made the gift has no legal right to get the property back. However, if gifts were made within a certain period before apply for Medicaid, Medicaid may not be available for a period of time that varies depending on the value of gifts, since the assets gifted will be considered assets just as if they were still owned. This can cause severe problems, since the property is gone, yet aid is not available. Sometimes due to the loss of income tax benefits as discussed above, tax savings could more than pay the premiums for a nursing home (long-term care) insurance policy. The actual numbers should be calculated for each individual situation in order to determine the best method of planning. Making gifts is not always the most advantageous alternative.

Prior to making any gift, it is essential to be certain that desired goals will be achieved. All ramifications of the gift should be analyzed and carefully considered before the gift is made. That way, gift giving, when appropriate, is a joyous occasion rather than something the client may regret.

If you have any questions please contact our office.


This content of this blog is intended for informational purposes only. It is not intended to solicit business or to provide legal advice. Laws differ by jurisdiction, and the information on this blog may not apply to every reader. You should not take, or refrain from taking, any legal action based upon the information contained on this blog without first seeking professional counsel.

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