Have You Considered Gifting to the Older Generation? Here's Why You Should
Gifting Appreciated Assets to Your Parents Can Make More Tax Sense Than Gifting Them to Your Children
Many are familiar with the concept of gifting to younger generations as an appealing and tax-efficient method of transferring assets, while keeping those assets in the family but out of the taxable estate of the person making the gift, the “gifter.”
However, upstream gifting, a strategy in which the younger generation gifts appreciated assets to the older generation, can capture significant tax savings as well, often more than traditional gifting.
Why Use Upstream Gifting
Typically, taxpayers use upstream gifting to support parents and grandparents, such as aiding with everyday living expenses, medical costs, or assisted living. There are potential tax benefits depending on whether the appreciated asset is needed immediately for expenses or can be held long-term by the elder recipient:
- If the asset is needed for living expenses, the elder recipient may have a lower capital gains tax rate than the gifter. With the top rate of capital gains tax being 20% (plus 3.8% Net Investment Income Tax) for federal and as high as 13.3% for state, the elder recipient may be paying capital gains at only 15% for federal and a significantly lower rate than 13.3% for state. It may even be possible that some of the gain could be taxed at a zero capital gains rate where taxable income is less than $80K for the elder recipient, if filing as a married couple.
- If the asset is not needed immediately for living expenses, the asset may be held by the elder recipient and, upon their passing, the appreciated assets will receive a step-up in cost basis to the market value at the date of death. Therefore, those who inherit the assets from the elder recipient at their passing would be able to sell those assets with little or no tax due. The inheritor may be the spouse of the elder recipient, the original giver of the asset, or any family member.
Risks and Considerations
In general, upstream gifting is appropriate for individuals with highly appreciated assets, who are looking to reduce potential tax exposure, and maintain close family relations with their older family members.
While upstream gifting can be an effective strategy for such investors, it does not come without risk. Upon gifting, the parent or grandparent now owns the appreciated asset(s), giving them the legal right to utilize, sell, give away, or pass them on to someone else. The gifter may have a reasonable expectation that the original asset may come back to them via an inheritance, but there can be no element of compulsion – they cannot, and nor should they, “force” the recipient to name the gifter as the inheritor of the asset – therefore close family ties are important.
An upstream gifting strategy has gift and estate tax implications as well. The initial upstream gift does not attract any gift tax if the gifter has unused Gift and Estate Tax Lifetime Exemption – this is currently over $12M per person – the upstream strategy uses part of this exemption – so a gifter needs to consider if they have sufficient excess of this Exemption Amount to cover the gift and their taxable estate when they themselves pass. If you expect your estate to be close to the exemption amount when you pass, upstream gifting may not be a good strategy for you. It is also important to consider that the federal estate / gift tax exemption amount is scheduled to reduce to approximately $6M per person in 2026.
- Differences in marginal capital gains rates between gifter and elderly recipient if the asset is to be sold and used for living expenses.
- Ensuring the step-up in basis is applied if the asset is held and passed on at death.
- Gifting uses a portion of your Lifetime Exemption Amount, currently $12M per person and moving to $6M per person starting in 2026.
- The will of the recipient needs to be carefully drafted and may need to be revised after the upstream gift.
- A close relationship between the gifter and elderly recipient must be maintained.
- The elderly recipient should be in good health – if the elderly recipient dies within one year of receiving the gift, the step-up in basis at death may be denied.
- The Lifetime Exemption Amount of the elderly recipient would also need to be considered to ensure that there is no estate tax due upon passing.
Upstream gifting is a strategic method to provide income tax and estate tax advantages for your family, while allowing multiple generations to participate in wealth-transfer planning.
For more information on upstream gifting, contact BakerAvenue to discuss how we can help you navigate the complexities of your highly appreciated assets.