Estate Planning for Highly Appreciated Stocks
Despite the market reversals of 2000-2001, large unrealized gains still reside in
many longheld stock portfolios built up during the record 1982-1999 expansion. How
do such assets fit into an estate plan?
Many estate plans include a program of regular gifts. From a tax perspective, gifts
have three advantages over estate transfers: The first $11,000 in transfers is shielded
from tax by the annual gift tax exclusion; appreciation in the value of the gift
after the transfer avoids taxes (effecting an “estate freeze”); and any gift tax
that is assessed is computed in a manner that is more favorable to taxpayers.
However, when the gift is to be of highly appreciated securities, there is an important
tax caveat. Such a gift comes with a potential capital gain tax attached to it.
The recipient of the gift takes the donor’s basis in the stock. When he or she later
decides to sell the stock, the tax on the capital gain will erode the value of the
In contrast, the basis of property received through an estate is generally “stepped
up” to its fair market value. Capital gain taxes will be due only on appreciation
in value after the decedent’s death.*
For married couples these rules suggest a simple tax strategy. For example, at his
death a husband bequeaths the appreciated stock to his surviving wife. The marital
deduction eliminates estate tax at that time. The wife, in turn, may make a gift
of the stock with a fully stepped-up basis. When family members receive these shares,
they won’t have to be so concerned about capital gain taxes. The wife may, however,
need to keep possible gift tax liabilities in mind and may want to spread such gifts
over a number of years.
Other ideas for highly appreciated stock in the estate planner’s toolkit
- Charitable trusts. For the philanthropically minded, a charitable remainder trust
or a charitable lead trust can be an excellent way to obtain tax-free diversification
of appreciated assets. There is no capital gains tax when the trustee sells low-basis,
high-value assets and reinvests the proceeds for higher yield. A wide variety of
choices is available to those designing a charitable trust, enough to meet both
charitable and private financial objectives on a tax-efficient basis.
*The stepped-up basis is scheduled for partial repeal when the estate tax is repealed
in 2010. Just $1.3 million of assets will then receive a stepped-up basis. Any excess
will carry over the decedent’s basis. An additional $3 million basis step-up will
be allowed on assets going to a surviving spouse.
- Private annuities. A private annuity is a sale by one family member to another in
exchange for the buyer’s unsecured promise to make specific periodic payments to
the seller for life. There is no gift tax due on a properly structured sale, and
the assets will be removed from the seller’s estate. A portion of each annuity payment
is a return of capital (part capital gain and part nontaxable return of basis),
and the balance is taxed as ordinary income. However, annuity payments by the buyer
are not deductible, and so are made with after-tax dollars.
- Family limited partnerships. A fairly new approach to managing family wealth is
the family limited partnership. This technique provides for consolidation of assets
for convenient management, segregation of assets for protection against claims of
creditors, and the potential for gift tax valuation discounts. Typically, parents
act as general partners, making gifts of small limited partnership interests to
children over a period of years. Properly structured, such gifts generally qualify
for the $11,000 annual gift tax exclusion.