Avoiding unnecessary taxation has long been one of the primary goals of drafting an estate plan for California residents. As we noted in a recent post, the federal gift and estate tax exemption will increase to $5.45 million on January 1, continuing an upward trend that began about a decade ago. As a result of the relatively high gift and estate tax exclusion, estate taxes are not a major concern for a large number of people.
But as estate taxes have declined in importance for all but the very wealthy, capital gains and income taxes have become more of an estate planning concern for those who do not have a substantial estate.
Federal capital gains taxes are collected when an asset is sold after it has gained value. In general, the tax is imposed on the amount the asset has increased in value since the owner purchased it. The original purchase price is known as the asset's "basis" for tax purposes. When a person dies, however, the basis of an asset in their estate is "stepped up" to its value on the date of death. When the asset is sold, this stepped-up basis reduces the taxable gain.
Assets that are put into a trust are not considered part of the estate and will not receive a stepped-up basis when the owner dies. Thus, if the person's total estate plus taxable gifts is not expected to exceed the exclusion amount, it may make sense to keep an asset in the estate if the heirs plan to sell it upon the owner's death.
The interplay of gift, estate and capital gains taxes can give rise to some complex estate planning issues. Those who want to pass on their assets with a minimum of taxation should seek advice about how to address this situation.
Source: Marketwatch.com, "5 ways to protect your estate from capital gains taxes," John O. McManus, Dec. 25, 2015