The Low Down on Cost Basis

A Common Mistake in Estate, Trust, and Inheritance Planning

By Financial Advisor Peter Egolf

Gifting Assets Before Death

A common mistake in estate planning of taxable assets (stocks, mutual funds, ETFs, physical property) is not understanding the impact of the cost basis of your assets. Specifically, gifting assets prematurely, in an attempt to avoid taxes, on assets that otherwise would receive a step up in basis at the time of death.

For example, if you were recently diagnosed with a terminal disease and you are looking to minimize the taxation of your Brokerage or Revocable Trust (e.g., taxable accounts) upon your death or to your beneficiaries, you might consider gifting those assets to your beneficiaries while you are alive to use up your lifetime estate and gift tax exemption (2024 transfer limit: $13.61 million per person) and transfer the assets tax-free.

At first glance, this seems like the right decision, but not in full context when you consider the potential taxes for the sale of the asset for the beneficiary.

Step Up In Basis After Death

Let’s say you purchased Apple at $10/share (nice job), and Apple’s current share price is $200.

If you want to give these assets to your daughter, you could gift them while you are alive, and she will keep your cost basis ($10/share).

However, if you left your shares of Apple to her after your death, those shares will have their cost basis stepped up to the fair market value on the date of death ($200/share).

Thus, by gifting your Apple stock to your daughter during your lifetime, she would have $190/share in unrealized capital gains that would be taxable upon the sale of the shares. Instead, these unrealized gains could have been completely eliminated by leaving the assets to her after your death, giving her a new higher cost basis that would help to minimize her taxes on the sale of the assets.

The same principle applies to other taxable assets.

Gifting a House Before or After Death

For example, a house you purchased for $100,000 is now worth $1,000,000. Gifting that asset leaves $900,000 of unrealized capital gains that would be taxable at the time of sale instead of potentially avoiding the $900,000 altogether by leaving this asset to the beneficiary after death.

A general principle to consider is gifting assets that have a high basis (low unrealized capital gain) while you are alive but leave low basis (high unrealized capital gain) assets to beneficiaries after your death via your estate plan.

High Net Worth Estates

There are caveats to consider, especially for larger taxable estates that approach the current lifetime estate and gift tax exclusions, where gifting high-basis assets to beneficiaries could be sensible to use up your lifetime estate and gift tax exclusion under the current elevated lifetime limits.

If you have questions about investments fit into your estate plan, contact me to schedule a conversation. We enjoy helping clients simplify their investments to meet their estate objectives, including working with your estate or trust attorney.