Question about step down in basis

[SecondCor521]

Suppose a single taxpayer owns a capital asset with an unrealized capital loss.

If they die, the capital asset gets a step down in basis to FMV on date of death.

If they gift the asset, the gifter gets a double basis which involves the FMV and the original basis.

If they sell the asset, they realize a capital loss that probably benefits them on their taxes, either to offset capital gains or against ordinary income up to $3K.

I'm puzzled why this Kitces article seems to recommend gifting over selling for such assets:

https://www.kitces.com/blog/capital-loss-at-death-step-down-gift-carryover-split-double-basis/

Is there some limit or rule against realizing capital losses shortly before dying?

 

[ERD50]

I kinda skimmed it, but he seems to be saying that the carryover loss is tied to the individual owner of a joint return. So if that owner dies, the carryover dies with them (the surviving spouse can't use it?)?

While it would be rare for anyone with a large loss to *not* have some gains to offset the loss, then those gains would not get the step-up benefit to the heirs.

But it also seems you want to gift losses to someone in a higher tax bracket than you, the opposite of gifting appreciated shares to someone in a low tax bracket (or charity).

-ERD50

 

[SecondCor521]

The example I'm wondering about is a single person, and an unrealized capital loss, not a carryover loss.

Imagine a Grandma widow who bought GME at $325 a share and it's now worth $120 or so but she hasn't sold yet.

 

[ERD50]

The example I'm wondering about is a single person, and an unrealized capital loss, not a carryover loss.

Imagine a Grandma widow who bought GME at $325 a share and it's now worth $120 or so but she hasn't sold yet.

OK, specifics (G-ma and a widow) help narrow it down. Now, I'm on my first cuppa, but I this is how I see it (similar to my earlier post).

Say she has a $2,000 unrealized loss in GME, and $3,000 in unrealized gains in other investments.

As I think about mapping out the options, I'm thinking that taking the loss against income is the best overall. Let's see:

A) She does nothing. Basis is stepped up at her passing. Heirs or estate sells right away, so little/no tax due, as they were sold at/near their step up/down basis. But G-ma got no tax benefit either.

B) She sells GME and enough other stuff for a net zero gain. No tax due. G-ma puts the proceeds in VTI, so no opportunity cost (and she gains diversification), and VTI will get the stepped basis for heirs.

This doesn't really accomplish anything tax-wise, G-ma paid no tax, heirs will pay no tax. But it does give a zero-tax path to diversify out of winning/losing stocks (which might recover, or drop, but that's any number of unknown scenarios).

C) She sells GME and takes the loss against her income (assuming she has taxable income - lots of wrinkles here!). She gets a tax benefit, and indirectly, so do the heirs as her state is a little larger by the (legal) tax avoidance.

D) She can gift the shares at their current basis. If an heir is in a high tax bracket, they would benefit most from the stocks with a loss, and vice versa. They *might* get a better tax advantage from this than if G-ma held or sold against her tax rate. With two heirs at each end of this, and if this was known to her, she could pick and choose which stocks to gift to each. And then we get into that "fairness" thing again! Does she gift equal face value amounts, or take into account their after-tax, in-the-pocket money (which would be hard w/o actually doing their taxes!).

I think that covers the options?

-ERD50

 

[cathy63]

...

D) She can gift the shares at their current basis. If an heir is in a high tax bracket, they would benefit most from the stocks with a loss, and vice versa. They *might* get a better tax advantage from this than if G-ma held or sold against her tax rate. With two heirs at each end of this, and if this was known to her, she could pick and choose which stocks to gift to each. And then we get into that "fairness" thing again! Does she gift equal face value amounts, or take into account their after-tax, in-the-pocket money (which would be hard w/o actually doing their taxes!).

The recipient of the gift doesn't actually get to take advantage of the loss though. This is the case of the "double basis". If $Y is Grandma's orginal basis, and the stock is worth $X when she gives it away, and $X < $Y, then the recipient has to know both numbers.

If the new owner sells at < $X, he has a loss. If the new owner sells between $X and $Y, he has a tax-free transaction. If the price recovers and the new owner sells at > $Y, then he has a gain from the $Y basis. It's usually going to be better for Grandma to realize the loss if she has other gains, though if the distance between $X and $Y is great enough and the stock is volatile enough, then I guess the recipient could try to time the market for a tax-free gain.

I didn't read the article, but this is how I remember it working, so hopefully I've got it right. Based on the discussion here, I'm not even sure what the point of the original article would be. The differences should be fairly minor for most cases.

edit: I looked at the article, and I think it's saying that the people who can get the most benefit from preserving capital losses through gifting are spouses in non-community property states.

 

[SecondCor521]

Thanks both.

Let's narrow it down further. Let's suppose widow Grandma doesn't have any unrealized capital gains, and that she has RMDs so she has ordinary income against which to offset $3K of losses.

If the unrealized capital loss dies with Grandma, and there is the double basis stuff if she gifts it, it seems it would be better for Grandma to sell the GME now to realize the loss and take advantage of it, unless there's some rule against it (which I don't think there is, but it's sort of why I'm asking the question).

Among the options @ERD50 laid out, it seems that (C) is better than (D). Using @cathy63's description, Grandma gets a better deal out of the loss than the recipient of the gift, because $X < $Y. And if she had a gain she'd just hold on to it for the basis step up. And if it's in between $X and $Y, then the giftee loses the loss that Grandma could otherwise realize and gain tax economic advantage from.

(Kitces is usually on the ball, and in the article he seems to suggest that Grandma gift it to the non-spouse heir rather than sell it. So I wonder if this is a case where I see something he didn't, or if he knows something I don't. Also, asking for a friend.)

 

[ERD50]

The recipient of the gift doesn't actually get to take advantage of the loss though. This is the case of the "double basis". If $Y is Grandma's orginal basis, and the stock is worth $X when she gives it away, and $X < $Y, then the recipient has to know both numbers. ... .

Thanks, wow, leave it to Congress to make this complicated:

https://ttlc.intuit.com/community/i...-basis-of-stock-i-received-as-a-gift/00/26892

The cost basis of stock you received as a gift ("gifted stock") is determined by the giver's original cost basis and the fair market value (FMV) of the stock at the time you received the gift.

If the FMV when you received the gift was more the original cost basis, use the original cost basis when you sell. This is the most commonly-encountered situation.

If the FMV when you received the gift was less than the original basis, and you later sold the stock for:

More than the original basis: use the original basis

More than the FMV at the time of the gift but less than the original basis: your selling price becomes the cost basis. You won't report a gain or loss in this situation

Less than the FMV at the time of the gift: use the FMV at the time of the gift

When you enter the sale of gifted stock, make sure you select the appropriate situation when we ask if you bought the stock. We'll calculate the proper gain or loss on your taxes.

Examples for original basis of $100, gifted @ $40 FMV:

Heir sells @ $110; Gain is $10 (110-100).

Heir sells @ anything between $40 an $100, cost basis is 'stepped up' to sales price, no tax.
(edit/add: and no tax break either!)

Heir sells @ $25; LOSS is $15 (25-40).

edit -posted before I saw @S521's reply, and have to run, so realize my post doesn't reflect anything in his post.

-ERD50

 

[all4j]

I didn't read the article either & also I'm not familiar with community property state wrinkles. But, I wasn't following where it is suspected kitces dropped the ball. Certainly I would agree that gifting isn't always, in every case, the best path. But, I think there are many scenarios where it would be.

The example may not be the best to illustrate the point. Question was raised whether there is a rule against realizing a capital loss "shortly before dying". I'm not aware of that if there is, but did kitces really limit the discussion to that? I would think the bigger issue would be when the unrealized loss would be more than would be offset -- & thus lost when looking at bigger picture.

And why "shortly" before death? Consider someone in their 80s who has social security & IRA rmds that more than cover their expenses. Their taxable assets are limited to their former employers stock that is now down $150k from their cost basis. Is it likely they'll use it up $3k/year if they sell? If they gift it now, the person getting the stock can see a $149k gain without tax right?

 

[SecondCor521]

^ I think Kitces may have dropped the ball in that article by not mentioning that sometimes realizing the capital gain and gaining the tax benefit is better than giving it away. In an article talking about the step-down in basis for non-spouses, it seems an oversight (unless, again, there is some rule or reason that it's always a worse idea).

The (admittedly narrow) scenario I'm interested in is where the unrealized loss is more in the $3K range, not the $150K range, and where the heirs/recipients don't want the asset because they don't expect the asset to go up in value and/or it just doesn't fit in their investment allocations.

 

[ERD50]

The (admittedly narrow) scenario I'm interested in is where the unrealized loss is more in the $3K range,

With a $3K total, even at the extremes of deltas in tax treatment, you aren't taking much, and those extremes probably aren't the case anyhow? And could be different for each heir?

I'd do whatever is most convenient and move on. If the heirs don't want it in that form, just sell it and distribute the cash along with everything else. Seems like they are giving you the answer (which is also the easiest for the executor/trustee). Don't look a gift horse in the mouth - take it!

-ERD50

 

[all4j]

Bottom line, I second erd50's post from earlier today. But will throw in some words.

I broke down & skimmed the article & don't think your scenario was what he had in mind at all. I saw words like 'may' & talk of avoiding knee jerk reaction's, etc. That is, I didn't read it to say selling or gifting were always the answer...it depends.

So, I think in your case he'd agree. We don't know the specifics of tax rates, etc to quantify, but I'd suggest looking past the financial aspect.

This may not apply to Grandma, but I know of a specific where this was true & I'll paint the scenario. She has 2 options: (1) gift the stock to her dear whoever & they'll feel so special they were remembered; OR, (2) admit she made a mistake in buying the stock & sell. Not saying she did make a mistake, but some feel that is admitting defeat. The other case I'm familiar with involved a bank after the gfc...buyer finally tried to sell, but only at a price higher than they paid. Because it was a good investment yadda yadda...

I hope Grandma lives for a long, long time. But if that doesn't seem eminent, I'd let her do it her way rather than spend final days 'correcting' her. ((I'll be 1st to say i have absolutely no reason to say that is indeed what is happening -- just offering a possible, & different, perspective))