MSU Extension: Gift While Alive or After Death?

This is a series of articles focusing on estate and legacy planning. The authors are Kaleena Miller, MSU Extension Madison-Jefferson County Agent, kaleena.miller1@montana.edu, and Marsha Goetting, MSU Extension Family Economics Specialist, marsha.goetting@montana.edu.

“Property owners have several decisions to make when it comes to estate planning, and one of those is whether to give property to their heirs before or after death,” says Marsha Goetting, MSU Extension Family Economics Specialist.

In deciding whether to make a gift before death or in a will, revocable trust, or testamentary trust, an individual should understand the difference between a “stepped-up” basis and a “carry-over” basis” on the property.

Let’s say a widow is trying to decide if she should gift her home while she is alive to her daughter or leave it to her after death. She and her late husband bought the home 40 years ago for $45,000, and now its value is $550,000. While there are personal considerations for one choice over the other, understanding the difference between a stepped-up and carry-over basis may influence the decision, said Goetting.

If the widow leaves her home to her daughter in her will, the basis in the home “steps up” from the $45,000 she and her husband paid to buy it, to the value upon her death of $550,000. “This eliminates the daughter’s income tax liability on appreciation in the property’s value occurring during the mother’s lifetime,” said Kaleena Miller, MSU Extension Madison Jefferson County Agent.

“In other words, if the daughter sells the house immediately after her mother’s death for $550,000, she does not have a state and federal income tax liability. If she sells the house a year later for $560,000, the daughter will only pay income taxes on the $10,000 capital gain in value after her mother’s death.”

“Property transferred as a gift before death has a carry-over basis, meaning the original cost basis of the house, less any depreciation, carries over to the daughter,” Goetting said. Because the home was not used in a business, the mother’s original basis of $45,000 was not depreciated. That makes the daughter’s basis in the house $45,000.

If the daughter sells the house for $550,000, she will pay state and federal taxes on the appreciation, called capital gain or increase, in the property’s value during the mother’s lifetime. If the daughter is in the highest income tax bracket, she could pay federal and state income taxes of more than $144,935.

In summary when an individual sells a property, not all the proceeds are taxable, said Goetting. When income is calculated, a person is only taxed on the difference between their “basis” in the property and its sale price. Generally, the basis is the amount paid to buy an asset, like a house, car, equipment, or stocks. The basis of some assets, such as equipment in a business, can depreciate. When this type of asset sells, the tax liability is calculated based on the sale price received minus the depreciated basis.

“People have worked hard for their property and should look at all the possibilities before making a final decision on whether to make a gift before death or at the time of death and take advantage of the current tax rules,” Goetting said. “If you are contemplating a significant gift, consult your accountant or attorney for an analysis of the tax or other legal consequences you should consider.”

More info can be found in the MontGuide Income Tax Impact When Selling, Gifting, or Leaving Property as an Inheritance, call 406-287-3282 or download at https://store.msuextension.org/Publications/FamilyFinancialManagement/MT202202HR.pdf.