How to Save on Taxes by Giving Stocks and Real Estate to Parents

• Selling appreciated assets such as stocks and real estate can result in high capital gains taxes.
• Moguls can save a lot of money by gifting assets to their parents, inheriting them back and then selling them.
• The ultra-wealthy can use upstream transfers to double the amount their children inherit without inheritance taxes.

Wealthy entrepreneurs face heavy capital gains taxes when they want to make money after building a successful business from the ground up.

But if they are willing to wait, they can save big by gifting their shares to their parents and getting them back when they die. Capital gains tax applies to the increase in value between the sales price and the cost basis of the asset, usually the purchase price. ‘Upstream transfers’ take advantage of a tax loophole for inherited assets, increasing the cost basis to the fair market value at the time of inheritance.

For example, a top earner looking to sell stocks that have increased in value by $1 million since he bought them would have to pay about $238,000 in taxes, according to Pam Lucina, chief fiduciary officer at Northern Trust.

But if they give the shares to their parents and sell them after inheriting them, they only have to pay that 23.8% tax rate on the value that the shares have increased in value since their parents’ death, even if the shares have increased in value after giving them. away.

You get the most bang for your buck by choosing assets with a low cost basis relative to their current value. Public equities, real estate and private business interests are popular choices, Lucina said.

Upstream planning is a powerful but risky tool, she told Business Insider. Individuals can lose their assets forever if their parents decide to share the assets with a new spouse or other children. She estimates that only a quarter of customers actually follow through with upstream planning after discussing it.

“Once you discuss the risks and the family dynamics aspect of it, it doesn’t work for every family,” she said.

Thanks to tax cuts during the Trump administration, individuals can give or leave $13.61 million before being charged a 40% federal estate tax. The high exemption threshold has made upstream planning more popular. Lucina expects donations to pick up before the tax cuts expire at the end of 2025, barring congressional action.

Robert Strauss, a partner at estate planning firm Weinstock Manion, typically uses upstream planning with ultra-wealthy clients who have already used their exemption but have less wealthy parents who have not yet done so. They can place assets in a trust that will benefit their parents until their death, and then the children. After the grandparents die, the children inherit the assets on a step-up basis. The federal estate tax does not apply as long as the grandparents’ estate does not exceed $27.22 million, the exemption for a married couple.

Buyer beware

1. The parents’ creditors may be entitled to the assets.

According to Lucina, the parents are usually given the power to decide on the assets to ensure that they are included in their taxable estate. This legal right gives parents the ability to donate or transfer assets while they are still alive. It also gives their creditors the ability to pursue the assets, she warned.

2. Make sure the whole family is on board.

Lucina said the best laid plans are more likely to fall apart when more people are involved, from siblings to spouses. For example, the parents may change their minds about leaving a larger inheritance to one child, even if that child gifts significant assets to them.

One of Lucina’s clients had to promise to pay the parents’ medical bills to get their siblings to agree to the arrangement.

Family dynamics are the most difficult part of upstream planning. Strauss said it is important to be transparent with everyone involved before the upstream transfer.

“You have to navigate the family dynamics to make sure that an upstream flow isn’t going to piss off other people or create an unrealistic expectation in a legacy that isn’t intended,” Strauss said.

3. The age of the parents is very important.

Although there is no hard and fast rule, Strauss typically uses upstream transfers when the wealth creator’s parents are at least in their 70s or are expected to live five years or less.

It’s a delicate balance. If the parents die within a year of the transfer, the assets will not receive an increase.

However, the assets are fixed during the lifetime of the parents. During that time, tax laws and the value of assets may fluctuate. It is possible to inadvertently be charged inheritance tax if assets exceed the exemption amount at the time of the parents’ death.

“Ideally, you focus on the exemption amount, not less, not more, but the value of the asset will change and the exemption amount will change,” Strauss said. “It makes it harder to deal with.”