Yes, You Actually CAN Do That

Last week my Slott Report article created something of a firestorm in my email inbox. Shortly after it was posted I began to receive a litany of emails, all written very respectfully, but all of which said my post was incorrect and that revisions were necessary in order to avoid Slott Report readers from making errors with respect to their planning.

To recap the article and the point of contention in a nutshell; I gave the hypothetical of a married couple, of which one spouse was about to pass and owned stock in his name only at a loss. I then suggested that a sly strategy would be to gift that stock to the other spouse prior to the owner-spouse’s death so as to preserve the potential loss. Many readers, via email, responded by saying this strategy wouldn’t work because the receiving spouse would receive the stock using the special “double basis rules” (explained below).

I only write about which I “know,” and I try to choose my words extremely carefully, so as not to mislead any of the many readers of the Slott Report, but I’m not infallible. Far from it (just ask my wife), and like everyone, I’ve made mistakes. So when the string of emails started coming in, many of which were written by attorneys and/or CPAs, some of which I know personally, I began to question myself “Is what I ’know‘ to be fact wrong? Did I present the benefits of a strategy that doesn’t actually exist?”

So of course I did some more research, quintuple checked myself, and much to my relief, I was actually correct. Which leads me to the point of my post today. I write this post not from spite, nor as some sort of triumphant “victory speech,” but rather because the deluge of emails I received last week clearly show this is an area that many professionals are not yet aware of and I want to clarify my post from last week and provide the necessary back-up.

With that in mind, in general, when a person gives away an asset that has a fair market value below its adjusted basis (cost), the recipient will receive the asset with a “double basis.” If the donee (the recipient of the gift) then sells the gifted asset, the tax consequences will be as follows:

o   Asset sold for less than the fair market value on the date of the gift: Donee gets capital loss equal to difference between fair market value on date of gift and sale price

o   Asset sold for amount between fair market value on date of gift and original donor’s adjusted bases: Donee has no capital gain or capital loss

o   Asset sold for amount above original owner’s adjusted basis: Donee will have a capital gain for difference between original donor’s adjusted basis and the sale price

The rules outlined above can be found in section 1015(a) of the tax code (which was cited in several of the emails I received last week as the reason my post was incorrect). As emphasized earlier however, the rules presented above are the general rules for when someone gives away an asset that has a fair market value below its adjusted basis. As is often the case when it comes to the tax code, this general rule has exceptions.

One such exception is when gifts are made between spouses. In such instances, the double basis complication outlined above ceases to exist. Instead, the receiving spouse’s basis in the asset is the same as the donor-spouse’s basis. This exception is outlined in section 1015(e) of the tax code, which reads:

(e)Gifts between spouses

In the case of any property acquired by gift in a transfer described in section 1041(a), the basis of such property in the hands of the transferee shall be determined under section 1041(b)(2) and not this section.

The section referenced in the above code cite, section 1041(b)(2), plainly states “the basis of the transferee in the property shall be the adjusted basis of the transferor.”

So there you have it. A spouse that owns an investment with an unrealized loss can give that asset away to a spouse prior to death in order to preserve the loss. Since most people have at least some assets with losses at any given time, and death is an event that everyone will face at one point or another, the clearly misunderstood strategy has ample significance for planners.

I will part today with this:

I would like to extend a very heartfelt “thank you” to the many readers of the Slott Report who not only took the time to read my post last week, but to write me with their concerns over its accuracy. It’s good to know that if, strike that, when I make a mistake in the future, there will be people out there willing to speak up to make sure our readers are always getting the most accurate information possible. I sincerely appreciate it.