Tax Strategy – Investments: Capital Gain Reduction

With tax rates increasing, especially for those in the higher tax brackets, we like to keep readers thinking about tax strategies.  The strategy I’m discussing here is geared for those that have appreciated assets (value has increased from purchased price.) These assets are typically subject to federal income tax, specifically capital gains tax if the assets are sold.  This strategy is a tax planning technique that depends on holding the assets for the life of either yourself or your spouse but allows your spouse to sell the asset free of capital gains tax.  So, if you would prefer to sell the asset quickly this particular strategy would probably not be for you.

As many of you are already aware, the current federal income tax system allows for a full step-up of basis for assets owned when an individual passes away, so long as the assets are included in the gross estate for estate tax return purposes.  This means that no federal income tax is ever paid on capital gains of appreciated assets from purchase price to the fair market value in the hands of the estate.

Joint ownership laws vary by state.  In some states including the state of Georgia, where we are located, there is joint tenancy with right of survivorship (JTWRS) or tenants in common.   Or, you or your spouse may own an asset in your name only.  If the asset is owned with joint ownership, you only get a tax-free step up on your portion of the asset owned.  When it is owned JTWRS with a spouse, only 50% of the asset will be stepped up upon the passing of the first spouse.

If the asset is sold after the first spouse passes away, the capital gain will be reduced.  However, if you believe one spouse may pass away first, given the lifetime tax-free gifts among spouses, you can put the entire asset in the name of the one spouse.  If the will gives the asset back to the other spouse, the asset will obtain a full step-up in basis and be able to be sold tax free after the passing of the one spouse.  Of course, if you are wrong on which spouse passes away first, you will gain no step-up on the passing of the first spouse.  There are many other considerations outside of tax consequences like the certainly the marriage won’t dissolve and the probability that the asset will be willed back to the gifting spouse after the ownership changes.

A handful of states operate under community property ownership between spouses. In those states you may get a 100% step-up regardless of which spouse passes away first, if owned jointly between spouses. So you need to know the law in your state and should get tax and legal advice for your area before making a decision to make a change.

Also, while I discuss some general strategies, there are some rules that need to be followed and some exclusions or adjustments needed for non-citizen spouses and others.  There are also some time periods for making transfers that must be followed or you will not gain the desired result.   You will need to get specific professional tax advice for your circumstances and set of facts to ensure this strategy makes sense for you.

Circular 230 regulations require all attorneys and accountants to provide extensive disclosure when providing certain written tax communications to clients. We would like to inform you that since this document does not contain all of such disclosures, you may not rely on any tax advice contained in this document to avoid tax penalties.