Whether it is securities, real estate, or tangible personal property, the desire to transfer something of value from one generation to another plays a significant role in estate planning. For individuals with taxable estates this can involve significant planning. For 2017, an individual has a federal “taxable estate” if he or she has more than $5.49 million in assets, or $11 million for a married couple. (1)
Personal possessions are often accumulated throughout life, but at some point there comes a time when there is a desire to pass on precious items. Sometimes gifts are made to family members who will cherish the items and the memories associated with them. Alternatively, items are sometimes donated to charities or nonprofits that are important to the family, to avoid favoring a family member.
Along with deciding who should receive the gift, a common question is: “Would it be better for me to give it now or transfer it as part of my estate?”
When we are thinking of “knowledge” with respect to making a gift, a great deal of satisfaction can be obtained when completing the gift during the donor’s lifetime.
The donor is able to witness the recipient’s appreciation of the valuable gift and make use of the gift, rather than waiting until death when the gift comes with significantly more mixed emotions around the loss of the donor.
A Typical Family Example
Without question, making gifts include personal decisions that should be made after thoughtful consultation with one’s advisors. Accountants and estate planning attorneys can help evaluate the estate tax circumstances and consequences of making a gift. Decisions, however, are often not simply about the numbers, as can be illustrated by the following example:
Consider a widow in her 80s with an $8 million taxable estate who wants to give away a $2 million painting. What factors should be considered?
In this case, the painting has been passed down more than 30 years ago to the widow/donor from her father. The donor – the family matriarch – has always cherished the painting and displays it prominently in her living room. With three adult children, all of whom have admired the painting for different reasons, she needs to consider each as a potential recipient and decide what would be best for her estate and her family:
- The eldest daughter would hope to display the work in her well-furnished house as a statement to her family’s commitment to the arts and significant appreciation for the artist;
- The donor’s son would not dream of displaying the painting. He is self-conscience about his family’s wealth and his only interest in the painting would be for its monetary value.
If he were to receive the painting, he would sell it for its cash value and use the proceeds to finance his travels in his retirement, because he has never planned for that stage of his life;
- The youngest daughter adores the painting as it holds great sentimental value to her. However, she is an aspiring artist herself and lives a nomadic lifestyle. She wouldn’t sell the painting, but is not sure exactly what she would do with it.
In addition, the lead curator from a well-known art museum has contacted the donor asking her to consider making a gift of the painting to the museum. Making a gift to the museum could provide her with a charitable donation to help offset her current income tax liability.
Is this important to the donor?
Factors to Consider
There are a number of factors to consider when making a major gift. The level of importance of each of these will vary depending upon the size of the property.
Recipient’s Interest: Given the family profile, advising the donor on the most appropriate recipient can pose challenges. An important consideration is whether a given recipient wants to own the gift. As surprising as it may be, the donor may not feel comfortable discussing the situation with family members before deciding who should be the recipient of the painting. Knowing that the recipient actually has an interest in owning the painting and has cherished a family heirloom can often bring great joy to the donor as well as the recipient. The donor will not experience this exchange of emotion if she makes the gift at her death, without telling the potential recipient. The donor’s ability to share the history of the work and its family meaning can be important. If the donor “knew” that her son would plan to sell the painting (despite capital gains taxes), this knowledge may also influence the her decision about gifting the painting to him. By exploring the interest and probable courses of action among all three of her children, the donor will be able to decide who may be the most suitable owner for the painting that is consistent with her own goals.
Value and Taxes: Another consideration is value. What is the real value of the painting? Again, here is where the “knowledge” comes into play. Has a recent fair market appraisal been prepared so that the donor is aware of the value she is giving away? Her cost basis is significantly lower than the current market value. If given to a family member during her lifetime, this gift will impact her lifetime gift tax exemption. Does everyone “know” that the donor’s tax basis in the painting will carry over to the recipient with a lifetime gift? This is different than if the donor holds it until her death and transfers it then. At that point, the tax basis would step up to the then current fair market value. If the painting will be sold, this could be an important consideration since the donor’s current tax basis from her father’s estate is significantly lower than the current fair market value.
Ownership Costs: The cost of insuring the painting is another important factor to consider. Depending on the painting’s valuation, the insurance coverage may be a significant additional cost to ownership. With more information about each child’s plans for and feelings about the painting, the donor can make a more informed decision.
Equality: If the donor makes the gift of the painting to one child, how will she equalize the value with the two other children? Is this important to her?
How will the recipient of the painting feel if their inheritance is illiquid while their siblings receive more liquid inheritances? Gift equality is not a mandated concept, but often helps promote family harmony. Knowing the current fair market value of the painting is essential in determining if a gift tax filing will be necessary. If the value of the gift exceeds $14,000, a federal gift tax return, Federal Form 709, will be required to be filed for the year of the gift. However, if the donor decides not to make this gift to a family member and selects the art museum as the gift recipient, then the gift is treated as a gift to a nonprofit institution, and the gift tax return may not be required. The museum must qualify as a charitable or nonprofit institution with 501(c) (3) status.
Timing: If the donor decides that rather than making a lifetime gift she would prefer to transfer the painting at her death, the estate tax impact may be significantly different. As previously mentioned, a donor has an annual exclusion of $14,000 per donee. Of course, when making a gift of a valuable work of art, this is less than meaningful. But when the work is gifted during one’s lifetime rather than at one’s death, the property is removed from the decedent’s taxable estate and any appreciation which may continue during the donor’s lifetime is also removed.
If the property is transferred at death the recipient will receive the property with the stepped-up tax basis reflecting the value of the painting at the widow’s death. With the stepped-up basis, the recipient of the painting has more flexibility in liquidating the painting, which could then be sold by the recipient with a lower capital gains impact. However, holding the painting until death does not remove the value from the taxable estate, unless the transfer is to a museum or charitable organization.
The considerations for making lifetime gifts or gifts at death require careful evaluation and analysis since the consequences can be far-reaching. These decisions are best when they are not made in a vacuum. Rather, when discussions with relevant family members as well as with estate planning and/or income tax professionals take place, gifting can better achieve the intended purposes.
(1) This article does not address individual state estate tax circumstances which could be material, depending on the domicile of the donor.