Capital Gains at Death

January 16, 2014. There are other things we have to be aware of when helping someone transfer their belongings at death besides the federal tax exemption and where stuff is going. One of those other things is capital gains taxes. There is a lot of finagling and maneuvering to minimize these during life, or altogether eliminate them, so it is not surprising that they have some role left to play at death. Summarizing capital gains, it is the profit you make when you sell property. Summarizing the capital gains tax, well, it is the tax you pay for that profit. However, worry over capital gains is severely diminished in today’s estate planning milieu, what with the federal exemption being so high and portability being adopted. A fortunate feature of death and owning property, if there can be any, is that property in your estate gets a step up in basis. Translated, it resets the profit calculation so that the starting value— the piece that you would subtract in the equation—is the value at death or thereabouts. Thus if the property is sold soon after, there should be little gains tax.

In light of this, the casual, instinctive response to the gains question is to rely on the marital deduction and give the property to the surviving spouse outright, so that at the surviving spouse’s death the property gets another step-up in basis, diminishing future gains further. For many, the exemption at the end of two lives will be more than sufficient to cover any estate taxes, and provide some justification for the approach. It is simple, after all. Of course, this reasoning is also the type of reasoning that nurtures postponing estate planning and shows a blind eye towards what should always be in the back of the mind, protecting the property transferred to the surviving spouse from their creditors. Fortunately, this can be accommodated by creating a special type of trust that makes use of the marital deduction but still bears the hallmarks of a trust, including asset protection.

The interesting scenarios develop where not all of the property is passing through the deceased spouse’s estate, so not all of the property gets a reset on its gains, yet the property desperately needs to be sold to support the surviving spouse. Unless you can accurately predict which spouse is going to pass first, and you really can’t do that well unless you have a hand in it, property is going to be divided more or less equitably between spouses. The half that doesn’t pass through the deceased spouse’s estate will not get the basis boost diminishing capital gains. Where value in the estate is high, and need of the surviving spouse low, this will not be a great concern. However, where property needs to be sold for support, the non-nullified gains tax might be quite the burden. It is thus on us to identify those scenarios and offer up the handful of workarounds.

Another issue of worth is when there is just enough wealth in a couple’s estate that it no longer becomes clear that at the surviving spouse’s death, and with the appreciation of assets, portability and exemption will be enough to eliminate federal estate tax. There is a difficult decision, then. Does one make use of a credit shelter in the first spouse’s life to plan for appreciation, but miss out on the basis step-up at the death of the surviving spouse? Exchanging estate taxes for capital gains. What if we discover, after making the credit shelter, that a federal estate tax would not have been due upon the death of the surviving spouse, and so there was a wasted opportunity to step-up the basis of the capital gains property? There is a clever and edgy wait-and-see approach to this problem, but it is for another time.

Questions about this and/or other estate planning topics? Goosmann Trust Law Counsel is ready to help you- visit the website at www.trustlawcounsel.com or call 712.226.4000.