22 Nov Can we use this strategy to avoid capital gains taxes?

Q. A good portion of my non-retirement assets are stocks and mutual funds that are jointly held with my spouse. If one spouse is terminally ill, does it make any sense from a tax perspective to make the terminally ill spouse the primary owner of the stocks and bonds and the surviving spouse the beneficiary? Thus when the primary owner passes away, the surviving spouse who is the beneficiary can get a step-up in basis and avoid paying capital gains if they sell the investments. For example, one purchased Facebook when it was $40 a share as joint tenants. Facebook is now $300 a share and the registration is changed from joint tenant to ownership of the spouse that is terminally ill. The primary owner passes away and Facebook is now $350 a share, the surviving spouse who is the beneficiary pays capital gains not on the original purchase price of $40 but on the $350 value of the stock.
— Trying to save

A. It’s a crafty move to save on capital gains taxes.

And it’s legal.

When you inherit property, from someone you receive a step-up in basis.

“Basis is tax speak for your cost. So inherited property comes with a basis equal to the market value on the date of death,” said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.

He said when a living person gifts you property, your basis is the giver’s basis. So a gift may come with a hidden tax liability, he said.

If you have a brokerage account jointly held by you and your spouse, you each have an undivided interest in the account, he said. If your spouse passes away the surviving spouse inherits the deceased’s interest in the account. This results in a step-up in basis for half of the account, he said.

You’re asking if the healthy spouse can gift their half of the account to the terminally ill spouse in order to receive a step-up in basis for the entire account.

“Yes, this is perfectly legal,” Kiely said. “Spouses can make unlimited transfers between each other free of gift taxes. When the terminally ill spouse passes, the survivor inherits the account with a date of death tax basis.”

Of course, there’s a “but.”

The law prohibits a step-up in basis if the property was gifted within one year of their death, Kiely said.

“By requiring that the donee spouse survive for at least one year after the transfer, IRC Section 1014(e) limited the ability of a tax free transfer to a terminally ill spouse and then the receipt of such property upon the death of the terminally ill spouse with a step up in the basis of the property,” he said. “Moreover, the Internal Revenue Service has also ruled that IRC Section 1014(e) will apply to portions of property that are held in a joint revocable trust funded with assets that were held by the grantors as tenants by the entireties.”

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This story was originally published on Nov. 22, 2021.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.