Gifting Assets Before Death: The Pros, Cons, and Misunderstandings

[00:00:00] Atty. James Jones: Welcome to Legacy Talk. I’m your host, James Jones. I’m an estate and probate attorney in Tacoma, Washington. I’ve been practicing for over 20 years, and my main practice areas include estate planning, probate, and estate administration. On Legacy Talk, we discuss topics surrounding families and estates.

[00:00:21] Estate planning is often a confusing and complicated topic. But my goal with this podcast is to make it understandable and accessible to those who need it. So if this is something that interests you, I’d appreciate it if you click the subscribe button and like this episode so that you can follow along as we break down the barriers to estate planning.

[00:00:39] I’m excited to get to today’s topic. Today’s topic is Gifting Assets Before Death, The Pros, Cons, And Misunderstandings, because this is a topic that we really need to talk about, because more mistakes can be made doing this than almost anything else regarding estate planning other than not doing it at all.

[00:00:59] [00:01:00] So on today’s show, we’re talking about Gifting Assets Before Death, The Pros, Cons And Misunderstandings.

[00:01:07] So let’s get to it. Gifting assets before death is often a misunderstood portion or part of estate planning. There are potential advantages as well as significant disadvantages. Failing to properly manage these gifts can lead to unintended consequences.

[00:01:25] It’s pretty common in my world to get calls from potential clients who say, I want to put my kid’s name on the house now, so when I die, they’re okay, or I’m going to give all my assets away before I die to my kids or my beneficiaries so they don’t have to deal with anything when I die. The answer to most of these inquiries that I get, and I tell most of my clients this, is we really need to analyze your specific situation to determine whether making gifts makes sense for you or not. Right?

[00:01:56] We really need to review each specific situation [00:02:00] to make sure it’s beneficial, right? Because one of the key focuses of estate planning is avoiding unintended consequences and addressing those worst case scenarios. So today we’re going to discuss the pros, cons, and misunderstandings of gifting during someone’s lifetime prior to death. Okay?

[00:02:21] So, estate planning and the strategy of gifting go hand in hand oftentimes with regard to someone’s estate plan, but it’s a nuanced area and it has significant implications, tax and otherwise, to someone’s estate.

[00:02:37] So, we’re going to talk about the pros, cons, and some misunderstandings. We’re going to start with the pros.

[00:02:43] The first pro is that it could potentially reduce estate tax liability, okay? Gifting during one’s lifetime can actually reduce the value of their taxable estate when they die. And so, that would in turn reduce their tax liability. This is particularly beneficial for large [00:03:00] estates that are over the state or federal estate tax exemption amount. Particularly in Washington, we have a very low estate tax threshold, which is 2.193 million as of this date of this recording. And that’s really low, right?

[00:03:14] We’ve talked about this before on this podcast, where if you’ve had a typical career, middle class career, I’d say, working at a company where you’ve got a 401k and you’ve got a house in Washington and you’ve saved well, you’ve got a taxable estate in almost all situations, right? With the property values here and the value that your money makes over time. It’s going to get up to that $2.1 million level more often than not.

[00:03:42] And so, reducing estate taxes is a significant portion of estate planning here in Washington and it can be federally too. So, one pro of gifting assets during your lifetime can be the potential reduction of estate planning or estate tax liability.

[00:03:57] Number two, the [00:04:00] lifetime exemption and annual gift tax exclusion. So, this is kind of a complex topic a little bit, and I’ll start with this. The state of Washington does not have a gift tax. Okay? There’s a federal gift tax and there’s a federal estate tax. That number is over $13 million, that exemption amount.

[00:04:19] And it applies regardless of whether you gift money during your lifetime or you die with that money. So, you have $13 million in change to play with at the federal level, but only 2.193 at the state level when you die. So, making gifts during your lifetime can eat away your federal exemption, but if you’re not worried about that, like most people aren’t worried about 13 point whatever million, and if it’s a couple of 26 point whatever million, right, 27 million.

[00:04:49] And so, a strategy potentially could be to gift your assets away and not worry about the state estate tax and be well under the annual or the federal exclusion. Also, you can make annual gifts and people get [00:05:00] confused with this, you can make annual gifts up to 18,000 per person per year without eating into that federal gift tax exclusion.

[00:05:09] And so, that can be a strategic way to transfer wealth. And we do that and we’ll talk about that a little bit later. So, if you gift within that lifetime exemption or under that annual exclusion, that can be potentially beneficial to your taxable estate down the road. So, that all goes back to taxable estates similar to the first one.

[00:05:26] Number three, the immediate benefits of recipients. So gifting allows beneficiaries to receive an immediate benefit. So sometimes parents want to make sure that their kids have some money while they’re still alive, right? Maybe they’re going through health problems, maybe they have a job problem, they’ve been unemployed or something, or maybe they’re putting their kids through college and they could use a little bit of extra money to afford that.

[00:05:50] Grandparents like to help with grandkids through college. They have the money, and so, providing gifts during lifetime would provide an immediate benefit, [00:06:00] allow the people making the gift to watch and enjoy the receipt of the gift by the beneficiary, or sometimes the taking for granted of that beneficiary, but ideally the joy that they received by getting that gift.

[00:06:13] And that could be basically worth it for them because they can see that enjoyment, they can see the accomplishment maybe of finishing college or their child being able to live a comfortable life if they’re unemployed or unemployable or disabled or something like that. So, immediate benefit to beneficiaries or recipients is a positive thing about gifting during your lifetime.

[00:06:33] And number four, goes along with that is educational opportunities. It provides an excellent opportunity to educate heirs about financial management, put them through college, about stewardship of assets and responsibilities that come with having wealth. One of the things we talk about on the legacy talk podcast is legacy, right?

[00:06:53] And so, when we create a legacy of planning and of saving and of investing and being prudent, you [00:07:00] know, giving gifts during lifetime and maybe giving a child or a grandchild, a little bit of money to invest and see what happens, you know, maybe they see, well, if I put this $1,000 or $10,000 in the stock market and I invest it wisely, that money’s more often than not going to go up over time. You know, historically it’s 10 percent or so, right?

[00:07:20] The return on an investment in the stock market. And so, that could be something where you could sort of educate the next generation, provide an example to that next generation and get them sort of situated with regard to the importance of financial management, managing their assets and strategic planning. Okay. So we did for four pros.

[00:07:42] Now we’re going to do some cons. Okay, I think there’s five cons here coming up.

[00:07:46] The number one con to gifting your assets away during your lifetime is loss of control. Who would have thought, right? Once a gift is made, you generally can’t get it back and you lose control over that asset.

[00:07:57] This is a significant consideration that people [00:08:00] make, is that if you gift an asset and overtime that asset might increase in value and maybe down the road, you might need that money for something, right? Making a gift, a true gift, a completed gift, as they say, in the tax code gives you no control over that gift going forward. Right?

[00:08:16] So if you give a piece of real estate, and the appreciation that real estate goes to the beneficiary, the recipient of the gift, right? If you give the stock, the increase on that stock goes to the recipient, right? The giftee, if you give cash, same thing, right? That person controls that money. They have no obligation to give it back to you or to say, Hey, did you need some of that money back?

[00:08:37] No, there’s, that’s not a thing, right? They have no obligation to do that, there’s no obligation for them to make any of that money back available to you, which could lead to number two, which is potential relationship tensions.

[00:08:49] This is a con number two, potential relationship tensions, gifting over someone’s lifetime or during someone’s lifetime can lead to [00:09:00] misunderstandings and tension among family members, especially if it’s done with sort of the understanding, Hey, I’m going to gift this money to you, but if I need it back, I kind of like it back.

[00:09:12] I’m going to give you this house, but I want to still live here. Right? Or gifting something to someone and saying, you know, I just did it because I thought it was the right thing to do and I’m changing my mind. Right? That could lead to major problems. Right?

[00:09:27] And also the other issue is what if you gift money to one of your kids over another kid that could leave those kids sort of bickering and fighting and being hurt or whatever.

[00:09:38] And so that tension could be a significant factor if you make gifts in an unequal way, I guess I should say.

[00:09:45] Number three. Medicaid implications. And so, this is a super misunderstood part of estate planning, this is worth a whole episode or series of episodes about Medicaid planning. But the simple is if you make gifts over your [00:10:00] lifetime, and this is something I’ll back up. People get confused with that annual exclusion, that 18,000 that you can give per year and gifting for Medicaid, any gifts that you make pre Medicaid are subject to a five year look back period. Okay.

[00:10:14] People think, well, I can give 18,000 a year, right? And that doesn’t count against Medicaid, no, that’s not true. That 18,000 annual exclusion is only with regards to the gift tax, not with regards to gifting for Medicaid. And so, if you make gifts for Medicaid, you really need to plan to do them at an appropriate time so that you’re not ineligible for Medicaid.

[00:10:36] You can’t wait too long, you sort of have to pre plan this significantly to make sure it works. And so, you want to make sure that you’re working with a good elder law attorney that does Medicaid all the time to sort of figure that out and not just say, well, I’m just going to give my house away, I can just do it. Right? And then I’ll be on Medicaid. Right? That’s not it, that doesn’t work. So don’t do that. Okay?

[00:10:56] Number four, capital gains tax for recipients. [00:11:00] Here’s the thing, recipients of gifted assets take the donors cost basis in the asset. So what does that mean to the average person? What is cost basis?

[00:11:12] I remember in law school, I took tax classes and we have like units on what’s basis. And for some reason it was, this foreign subject, I don’t know why it’s not that complicated, but it was this foreign idea that I had never heard about before cause I was a college kid. But when you gift an asset, the recipients receive the same basis that you have.

[00:11:33] So say for example, you bought a house, okay. And you paid a hundred thousand dollars for that house. And when you gift that house, it’s worth $200,000. Okay, for simple math purposes, your basis is somewhere around $100,000. Okay, for simple explanatonary purposes. Okay.

[00:11:55] So when the kid or the recipient of that gift goes to sell the house, say that the [00:12:00] recipient of the gift holds that house for another 10 years, and it’s worth $300,000. Okay? And these are not real values, of course, Washington, they’re significantly higher, but you had a hundred thousand dollar basis, you gifted to someone when it’s worth 200,000, they still have that same $100,000 basis, but when they go to sell it 10 years later, it’s worth 300,000. So their potential capital gain on this property is $200,000, right?

[00:12:26] And so, that’s because they inherited or they had a carryover basis from the recipient. And so, basically what their investment is. So capital gain is, gain or sale price less basis equals what the gain is. So if it’s 300,000 minus 100,000, that’s 200,000. Okay.

[00:12:45] And so, their gain is $200,000 on this property and they’d have to potentially pay capital gains on that. And that’s a bad thing, right? The alternative is, if you inherit an asset, say the person inherited that same house, the mom had this house. She bought it for a [00:13:00] hundred thousand and she, when she died, it was worth 200,000. That beneficiary of that house gets the stepped up basis. So it’s advantageous for them to receive the house through an inheritance.

[00:13:12] So they would get the basis at the time of death, which is the fair market value. So when they go to sell it in 10 years and it’s worth 300,000, their gains only a 100,000 instead of 200,000. So it’s oftentimes better to inherit an asset for basis and capital gains purposes than to have a gifted during lifetime.

[00:13:29] Number five, this is a huge thing. Okay. This goes back to, I want to put my kids names on this house, I want to put all my kids names on the house and when I die, I’m not going to have to worry about anything. They’ll just have the house, my name will fall right off there and the kids will have the house and I’ll be so happy.

[00:13:45] Number five, liability. If you gift your house to your kids or put their name on a piece of property or a bank account, investment account, there’s a couple things that could happen. One is, if we’re talking [00:14:00] liability, if something happens to that kid, right? Or the person that’s on your account with you or on your house with you, say they get in a bad accident, car accident, and they get sued, and their insurance won’t cover it, or they won’t cover all of it, right? And so they’re paying out of pocket for some of this.

[00:14:13] Guess whose house is also on the hook for that judgment? The one that their name is on, which is your house, right? So there’s your house is subject to their creditors, same thing with bank accounts, same thing with investment accounts.

[00:14:25] So you really want to consider, do I really want to put my kid’s name on my house or my bank account and open yourself up for potential creditor attacks from creditors that aren’t even yours? I recommend strongly against it, honestly, and it really doesn’t do what it’s supposed to do. It doesn’t avoid probate to put your kid’s name on the house.

[00:14:43] And so, it’s not even worth it in the long run, unless you do it certain ways, which we’re not going to get into, but there’s a couple of ways to do it where you could avoid probate that way.

[00:14:52] But the typical way people do it is not the way that avoids probate. It’s not typically with joint tenants with right of survivorship, which is the way that owning real [00:15:00] estate could avoid probate. If it’s not a trust or something, which we’ve talked about, but liability is a big problem, that’s a big negative about gifting assets to your kids or family or friends during your lifetime.

[00:15:12] Okay. Now let’s get into the misunderstandings, okay?

[00:15:15] Gift tax misconceptions, that’s number one. Many people misunderstand the gift tax and assume that the recipient pays the tax. Okay? So people always say, well, if you give me that money, do I have to pay tax on it? Is it income? The answer to that is no.

[00:15:30] Gifted money is not income. Okay? The reality is that the donor, the gift door is the one that would be subject to potential gift tax based on the value of the gift. And I’m not going to say that this is that huge of a deal, particularly in the state of Washington where we don’t have a state gift tax yet, but there is a federal gift tax.

[00:15:49] But like I mentioned before, there’s an exemption up 13 million and change for the gift tax. And so, most people aren’t hitting that during their lifetime. Honestly, the [00:16:00] vast majority of people are not hitting that because their states are under $13 million. But if you do have a larger estate, it could be an issue, right?

[00:16:08] I’ve several clients with larger states that are over that $13 million threshold and gifting in a irresponsible way could just lead to more taxes. That’s a misconception.

[00:16:18] Number two, misunderstanding, equality versus equity and gifting. There’s a common misconception that all gifts must be equal to be fair and, you know, certain situations call for certain types of people or certain people or recipients in different circumstances to get more maybe than others.

[00:16:39] This like comes up a lot in my practice where, well, Johnny’s doing really well, but Bobby’s not doing great. Johnny’s got a great job and he’s got a house, but Bobby doesn’t have a house. Bobby’s working at McDonald’s or something, no offense to people that work at McDonald’s. But he’s, you know, so parents might say, well, Johnny doesn’t need the money, I’m going to give it to Bobby. Okay.

[00:16:59] I’m going to [00:17:00] give more to Bobby than Johnny and Bobby might be super happy about that and Johnny might be perfectly fine with it, but he might say, well, I’ve worked hard for this money, why is Bobby getting more than me? Right? Why does he entitled? Because he didn’t work as hard and isn’t as successful as me to get money, you know, to get a share of money, more and more share than I get. And so, that can cause tension back to the con. Tension between the family.

[00:17:25] And so, you don’t have to do anything that you don’t want to do, right? You can give to whomever you want. You don’t have to give anything to Johnny if you don’t want, you can give everything to Bobby, but that could cause problems and it doesn’t have to be equal. You do whatever you want. Right? This is a free country.

[00:17:40] So number three, misunderstanding, the irrevocability of certain gifts, some gifts, especially those made into trusts, maybe irrevocable, meaning that they cannot be taken back. We talked about this, that’s the start of the episode, right? Most gifts that you make are that are completed gifts are not coming back, right?

[00:17:56] Without the goodness of someone else’s heart, [00:18:00] right? The permanence of these gifts is often a major misunderstanding at the time of the gift. And so, if you make a gift to a trust or make a gift to a child or a friend, it’s better not to make it with a wink necessarily, right?

[00:18:13] If you think you might need that money, you may not want to gift it, right? If you think you might need that money down the road without an agreement, without explicit trust in the recipient, if that’s your child. And I say, mom, I’m going to take care of you, dad. I’m going to take care of you. I wouldn’t do it, right? There’s other ways to get around not having money in your estate. Okay?

[00:18:33] So you have to understand if you make a gift, you might not be getting that back and you have to make the gift with the understanding that I can be perfectly fine as long as I don’t get this money back, I’m fine.

[00:18:43] And if that’s the case, go ahead, right? But if not, then you shouldn’t be making that gift. Okay. Without some guarantees.

[00:18:51] Number four misunderstanding is the impact on your estate plan. Gifting assets without adjusting your estate plan [00:19:00] accordingly can disrupt intended inheritances and the balance of asset distribution among heirs, and this is often overlooked.

[00:19:09] This goes back to the Johnny, Bobby problem, right? Well, Bobby’s been living at home all these years, and we’ve been helping him, or we had him move out, and he got an apartment, and we’ve been helping him pay rent for the last 10, 20 years, and Johnny’s out, you know, working a regular job, living independently and successfully.

[00:19:27] And so, Bobby’s gotten all this extra money and Johnny gets very little, right? Or he gets half of whatever’s left, but Bobby’s gotten the lion’s share. And so, if you don’t sort of offset that in your estate plan or do gifting with regard to like an eye on your estate plan, overall, you can have problems, sibling problems, family problems, tension that causes, or is caused by these errant gifts without foresight, okay. We’re hindsight.

[00:19:56] So, the strategy around gifting assets before [00:20:00] death should be tailored in each situation to the individual making the gifts and their circumstances and their goal. And as with all the things on this legacy talk podcast, we want to do everything with the help of an experienced estate planning attorney, rather than doing it willy nilly on our own.

[00:20:18] We don’t want to read what Google says to do about gifting and then just do it, it’s nice to get a second opinion and have expert guidance. Because there’s complex legal and tax problems that go with gifting that you really don’t want to miss. Okay. You don’t want to do it wrong.

[00:20:32] So that leads us to our story time of this episode. And it’s super timely actually this week, the first story this week, I’ve got two stories. This week’s episode, the first story just happened this week and a client came into my office. And she came in with the understanding that she wanted to talk about putting her house in a trust so kids wouldn’t have to go through probate and be easy to administer.

[00:20:54] And in the meeting, we’re talking to the lady and we discovered that years ago, I think 10 years [00:21:00] ago or so, she met with an attorney who advised her to gift her house to her kids. And reserve a life estate for herself.

[00:21:07] And so 10 years ago, she gifted the house to her kids, there’s five of them, I recall. And she reserved a life estate for herself. A life estate is basically a right to live in the house until you die. Okay.? So kids, you own the house, but I can stay here till I die, that’s what a life estate is. And we found the deed that was online on the auditor’s office records, and the problem with this is she’s not getting that house back. Right?

[00:21:33] The problem was one of her kids is deceased since this 10 year ago gift. One of their sons died, leaving a daughter in law who is not friendly with the family and we found out that two other kids that were named and given this house who own this one fifth interest in this house, she hasn’t talked to in 10 years.

[00:21:55] And so, in reality, she’s going to be out of luck, right? Unless she can [00:22:00] convince this adversarial daughter in law to have sympathy on her and give me that my son’s portion of that house back, please, or, and, or get in touch with those two other semi estranged kids that she hasn’t talked to in 10 years, she’s not getting the house back. And so she’s out of luck there, right?

[00:22:20] She wasn’t optimistic that she could talk to the daughter in law or to the two other kids. And I wasn’t optimistic that we could help her on it either because she made a gift, it was completed gift, it was not under undue influence and she wasn’t coerced into making it. I don’t think, and so she’s out of luck.

[00:22:34] So that’s a major unintended consequence, she wants this house still, she wants to potentially sell it, right? She wants to be able to use the money, but she’s already given it away. And so, that’s story number one. That’s a bad thing, yeah, that’s bad.

[00:22:50] Number two is a different situation. Number two is a high net worth client of mine. And they have a taxable estate federally and statewide. And so, we implemented a [00:23:00] strategy to gifts annually under that annual gift exclusion, a portion of a company that they own to their kids. And so we set up irrevocable trusts that can hold their children’s interests in their inheritance.

[00:23:14] And these trusts are designed to allow you to make a gift and basically protect the gift from being subject to the kid’s creditors. And from, you know, liens and garnishments and divorce and all that stuff. Okay.

[00:23:27] The problem with this, there was a case years and years ago called the crummy case. And so in order to make a gift to a trust, you have to give the beneficiary of the trust right of withdrawal. And they have to have a certain period of time where they can withdraw the funds after the gift is made.

[00:23:41] So it can be considered a completed gift, okay. And so, when you do these gifts, we assign these shares of this company to the trust and we write a letter to the beneficiaries and say, Hey, we made a gift to the trust and it’s worth $18,000. This is not money though, [00:24:00] it’s a piece of paper. Really, it’s a stock certificate basically and we put it in the trust and we say, Hey, we put this $18,000 gift in the trust. And you have the right to pull this money out within a certain period of time and, you know, if you don’t, then it’s in the trust, right?

[00:24:16] And so, the idea behind this plan is you gift away fractional shares of a company or something, or an asset over time under this $18,000 exclusion. And at the end, the value of those assets are not part of your taxable estate, which is the goal here for these clients.

[00:24:32] Problem within their family was a couple of their kids said, well, when we sent that letter out, I got a couple of emails on the call from a couple of beneficiaries saying, Hey, how do I get that money out of this trust? And so, it caused kind of a problem within the family that they were not intending, right? They thought the kids would be on board with like, okay, we’ll put this share of stock essentially into this trust.

[00:24:57] You could just leave it there and you can get it when we [00:25:00] die, right? You can access it when we die, but don’t touch it for now. And so, it caused a pretty big rift between two of these gift recipients, which are kids of my client and my clients. And so, it shows that there’s problems making gifts, even if it’s just an estate planning tool that’s been used for years and years.

[00:25:16] If it’s not understood well or not explained well or misunderstood completely by beneficiaries, it can backfire, right? And so that’s what happened in this case. So, gifting during lifetime is not always foolproof and it’s often a problem, right?

[00:25:34] Are we getting there? Did we get that out of this episode? It can be a problem, and so, we want to make sure that when we’re doing gifts, if it makes sense to do it, sometimes it does make sense, right? Sometimes it’s just perfectly good strategy and it’s an advisable strategy, but if it’s done improperly, it can backfire and have unintended consequences.

[00:25:53] And the whole idea behind a state planning is we want to address issues before they [00:26:00] become problems, right? We want to plan today, our logo here, slogan plan today for peace of mind tomorrow, right? We don’t want to have to create more problems through things that we’re doing with our state and gifting improperly. Can be one of those problems. Okay.

[00:26:19] And so that’s it. That’s today’s episode. Thanks for listening to today’s episode of legacy talk. If you liked today’s episode and would like to learn more, please like, and subscribe for more great content. I’ve been your host, James Jones to your legacy.