Capital Gains Taxes Attorney in Cary, North Carolina
What Are Capital Gains? how Do Capital Gains Work?
Capital Gains Tax is a tax on the gain or appreciation of an asset when you realize it when selling it. For example, if you bought stock in a company at $5 a share in the 1990s and then sell those shares in 2015 at $100 a share, your gain or appreciation is $95 a share. The IRS will tax you a certain percentage on each share. The amount varies based on short-term and long-term gains. Either way, there are taxes.
What does this have to do with Estate Planning? Well, some people, who are aware of Probate, try to avoid Probate by giving away their assets before they die. For example, a landowner gifts the land to their children during the landowner's life. This works well to avoid Probate and saves the expense, delay, and hassle your loved ones may encounter through Probate. It may also make the landowner feel like it is settled and stop worrying about what may happen. However, in most cases doing this results in a substantial increase in Capital Gain Taxes. The reason why for this is the IRS's use of "carry-over basis" and "stepped-up basis".
"Carry-over basis" simply means the person who was gifted (received) the asset pays the taxes on the gains (appreciation) that both the giver and receiver realize. "Stepped-up basis" simply means the gain (appreciation) that occurred during the ownership of the giver is reset to the value of the property upon receipt by the receiver. The gains (appreciation) made during the ownership of the giver are forgiven and avoided. A "carry-over basis" causes a bigger tax bill.
Gifting property (real estate, stocks, etc) during your life to an heir creates a carry-over basis in the tax liability on the future sale of that property which causes an heir to pay taxes on both the gain (appreciation) that happened while you owned the property and on the gain (appreciation) that happened while an heir owned the property.
For example, say you purchased a beach or mountain home in 1985 for $30,000. Your family loved vacationing there for many years. You've updated the property and it is a very desirable piece of real estate. But now you're older and don't visit the vacation home much. So, you decided and gifted the home to your 2 children so they can take control and manage it now with their children. The home is worth $200,000 when you gifted it to your children. A few years later you pass away when the home was valued at $215,000. Your children use the home and enjoy it for a few more years but then they decide neither are using it much and it's now $250,000. So, your children decide to sell and are shocked when the IRS charges them capital gains taxes on $220,000 of the $250,000 sale price. What happened? Well, the IRS imposed a "carry-over basis" on the gains (appreciation) that occurred from the amount you paid for the home and the amount your children sold it for (sale price $250,000 - carry-over basis purchase price $30,000 = $220,000 capital gains).
How to Avoid Capital Gains Taxes?
Estate Planning with an estate planning attorney is a good way to avoid paying capital gains is through inheritance and taking advantage of and benefiting from a "stepped-up basis". Remember, a "stepped-up basis" is a reset of the tax basis and wipes out liability on the gain (appreciation) that occurred during the ownership of the property purchaser.
Using the same example above, let's see how a slightly different decision would avoid capital gain taxes.
In order to avoid the "carry-over basis" and capital gains taxes, you should not gift the beach or mountain home to your two children. Rather you should make sure they inherit it, either through your Last Will or your Trust. When someone inherits property the IRS gives the beneficiary a "stepped-up basis" and wipes out all the gains (appreciation) that occurs while you owned the property. The beneficiaries will then be liable for only the appreciation (gain) while they are the owner (the value on the death of your death until the day the beneficiary sells).
The easiest thing would be to designate in your Last Will for your children to receive the home. However, this shortfall of this decision is it keeps you as the owner of the home and you keep all the homeowner burdens. If you want to pass off this burden, a solid option to consider is to set up a Trust, wherein you name your children as the beneficiaries of the home and you give them control of the home now, during your life, and after your death. Then you have the home transferred to the Trust when it was valued at $200,000. You control the trust so the home is still considered yours, for tax purposes, even though your children can now legally take care of it relieving you of that burden. This means no change in tax consequences. Upon your passing, your kids continue enjoying and benefiting the home for those few more years until they sell it for $250,000. The tax liability decreases from $220,000 gains under "carry-over basis" to $35,000 gains under "stepped-up basis" (sale price $250,000 - stepped-up basis inherited value $215,000 = $35,000 capital gains).
You can provide a much greater inheritance to your heirs (beneficiary) by becoming aware, keeping up with these legal developments and changes, and having a good estate plan that makes this all happen. Working with an estate planning attorney is a solid approach to having a good estate plan and keeping it up to date.
Additionally, if you an estate beneficiary will be a Charity or multiple Charities you should learn about and consider a Charitable Remainder Trust to avoid capital gains taxes, create an income stream for yourself and/or others, and gift the remaining value to your favorite charity or charities.