Liz Weston: Large gifts potentially reduce amount a wealthy donor can pass on to heirs tax free

Dear Liz: He recently wrote about the tax implications of capital gains when someone sells a home they’ve been given, versus one they’ve inherited. Would you elaborate on the estate ramifications for the donor if that person has a large estate? Would your estate pay gift tax?

Answer: Few people have to worry about gift or estate taxes, for reasons that will become apparent in a moment. But large gifts can potentially reduce the amount a wealthy donor can pass on to heirs tax-free after death.

This is because the gift and estate tax systems are combined. Gifts above the annual exclusion amount, which in 2023 is $17,000 per recipient, reduce the donor’s lifetime gift and estate tax exemption, which in 2023 is $12,920,000.

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Let’s say a donor gives a $1 million house to a friend. The amount in excess of the $17,000 annual limit, or $983,000, is deducted from the donor’s lifetime limit. If the donor were to die in 2023, the amount of his estate in excess of $11,937.00 would be subject to estate taxes. (Donors only owe gift taxes after they give away so much that they exhaust that lifetime limit.)

Receiving property as a gift also means that the recipient may face more tax than if the property had been inherited.

The previous column mentioned that when someone inherits a home, the home’s taxable basis is “stepped up” to the current market value. This means that appreciation that occurred during the lifetime of the previous owner is not subject to tax.

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If someone is given a house by a living donor, different rules apply. There is no increase in value. The recipient gets the donor’s tax basis, which is usually what the donor paid for the home, plus any qualified improvements.

When the house is sold, that basis is deducted from the income to determine the potentially taxable profit. The recipient could face capital gains taxes on the appreciation that has occurred since the original owner purchased the home.

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On the other hand, gifting assets during life is a way to control the size of a potentially taxable estate, says Los Angeles estate planning attorney Burton Mitchell. Once the house is given away, for example, its future appreciation will not increase the donor’s estate.

Anyone with a large enough estate to worry about these taxes should, of course, consult an estate planning attorney about the best strategies for their situation.

Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions can be sent to 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or via the “Contact” form at askliweston.com.

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