Liz Weston: Large gifts potentially reduce amount a wealthy donor can pass on to heirs tax free

Dear Liz: You recently wrote about the capital gains tax implications when someone sells a home they were given, versus a home they inherited. Would you elaborate on the ramifications of the estate for the donor if that person has an estate? Would the estate pay tax on the gift?

Answer: Few people have to worry about either gift or estate taxes, for reasons that will become obvious in a moment. But large gifts can reduce the amount a wealthy donor can pass on to heirs tax-free after death.

That’s because the gift and estate tax systems are combined. Gifts in excess of the annual exclusion amount — which in 2023 is $17,000 per recipient — reduce the lifetime gift and estate tax exemption of the donor, which in 2023 is $12,920,000.

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Let’s say a donor gives a friend a $1 million house. Amounts in excess of the $17,000 annual limit, or $983,000, are deducted from the donor’s lifetime limit. If the donor died in 2023, the amount of the estate in excess of $11,937.00 would be subject to estate tax. (Donors are only subject to gift tax after giving so much that they use up the lifetime limit.)

Receiving property as a gift also means the recipient may face more taxes than if they had inherited the property.

The previous column mentioned that when someone inherits a home, the home’s tax base is “stepped up” to the current market value. This means that the appreciation that occurred during the lifetime of the previous owner is not subject to tax.

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If a living donor gives a home to someone, different rules apply. There is no increase in value. The recipient receives the donor’s tax basis, which is typically what the donor paid for the home, plus any qualified improvements.

When the house is sold, this basis is deducted from the proceeds to determine the taxable profit. The recipient could face capital gains taxes on the appreciation that has occurred since the original owner purchased the home.

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On the other hand, giving away assets during life is a way to control the size of a taxable estate, says Los Angeles estate planning attorney Burton Mitchell. Once the house is given away, for example, its future appreciation will not increase the donor’s estate.

Anyone with an estate large enough to worry about these taxes should, of course, consult an estate planning attorney about the best strategy for their situation.

Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions can be sent to him at 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the “Contact” form at. askliweston.com.

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