While deathbed gifts may make for good television, they rarely constitute good estate planning. In fact, deathbed gifts usually result from our own inaction as no one likes to think about dying or plan for their own death. Thinking about your own death is stressful and unsettling as you consider your loved ones and their wellbeing after you are gone. However, you are likely setting your loved ones up for even more stress and grief after you pass away if you fail to create a good estate plan or keep that plan updated.
So while deathbed gifts may solve some shortcomings, these gifts made while you are alive, even on your deathbed, bring their own set of problems.
No Step-Up in Basis
Deathbed gifts can be costly because they are not entitled to a step-up in basis. The “basis” you have in property is essential to determine whether any capital gains have been made, and consequently whether any capital gain taxes are owed when the property is sold. Under federal tax law, a capital gain occurs if property is sold or exchanged for more than its original price. The original price is called its basis.
Federal tax law provides that the basis of any inherited property steps up to its fair market value at the date of death. So, if the value of your property appreciates over time, the property will be worth more at the time of your death than when you bought the property originally. Applying the federal law, the step-up in basis wipes out the appreciation in value and any sale of the property immediately after your death will likely not result in any gain, and no capital gain tax would be owed.
In contrast, if you make a gift during your lifetime, even one minute prior to your death, the recipient of your gift will have the same basis you had (the “carry-over basis”). As the gift recipient is not entitled to a step-up in basis, sale of the appreciated property will result in a gain, and the gift recipient will owe capital gain taxes on the sale of the appreciated property just as if you had made the sale prior to your death.
Example: If, on your deathbed, you decide to give your son a valuable painting you purchased in 1975 for $20,000 that is currently worth $150,000, the painting has appreciated in value by $130,000. Your son’s carryover basis in the painting is the same as yours—$20,000. As a result, if your son decides not to keep the painting and sells it for $150,000, the increase in value of $130,000 will be taxable as capital gain to him. In contrast, if your son inherits the painting at your death, his basis will be stepped up to $150,000, its fair market value on the date of your death. If he immediately sells it, he would have no capital gain, and thus, would benefit from significant tax savings.
Possible Inclusion in Your Gross Estate
If you are very wealthy, you may employ a strategy of making lifetime gifts as a way of decreasing the size of your estate and minimizing your liability for estate taxes. This strategy involves making gifts of no more than the annual exclusion amount, and you are free to make an unlimited number of gifts for less than the annual exclusion amount. For 2023, the annual exclusion amount is $17,000, so, only gifts of $17,000 or more, have to be reported to the IRS and are deducted from your lifetime exclusion (currently, $12.92 million). Consequently, if you make gifts to ten (10) people of less than $17,000, you can reduce your estate by nearly $170,000 this year, and if you continue this practice for nine more years – at the 2023 exclusion rate – then you can reduce your overall estate by $1.7 million within 10 years.
Similarly, if you are on your deathbed, then you can reduce your estate this year by the same $1.7 million by giving the same gift of less than $17,000 to 100 people. However, to accomplish this reduction to your estate, the gifts must be “completed.” The definition of a “completed gift” will depend on state law. For example, the law could require that in the case of a gifts made by check that the checks be cashed (cleared and posted to the recipient’s account) by the time of death. And if you wait until you are on your deathbed to write those checks, any checks that have not cleared and posted to the recipients’ accounts will be included in your estate as those checks are not considered “completed” gifts.
Doubts about Your Capacity
Deathbed gifts may raise questions about your capacity to make decisions. To make a valid gift, you must have the mental capacity required by state law, but those standards vary by state. Some states apply the same standard that must be met to make a valid will:
If you make a gift on your deathbed, the gift may disrupt your estate plan or the expectations of those people around you (i.e., had you not made a gift of the property, then these people would have likely inherited that gifted property). These unhappy people may subsequently question your mental competency to make the gift on your deathbed. Although making a gift on your deathbed is not enough on its own to show that you lacked the capacity to make the gift, these unhappy people can make a litany of arguments to question the validity of the gift:
Because any such argument would have to be resolved by a court, deathbed gifts do not create legal certainty and may even propel your loved ones into family splitting litigation.
We Can Help You Plan Ahead
While deathbed gifts can be useful, associated risks however may outweigh the benefits of making such gifts. We can help you minimize these risks if you must engage in deathbed gifting. However, you can avoid these risks by creating a careful estate plan and keeping that plan updated. While a good and updated plan should reduce any taxes that could be owed and preserve family harmony, the plan should most importantly provide you the peace of mind that you have done what you can to take care you and your loved ones. Talk to us about creating a careful and thoughtful estate plan and keeping the plan current to meet the challenges and changes in your life and in the lives of your loved ones.
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