Gifting in Washington State

As the holidays approach, you may find yourself thinking about the important people in your life and how you can best outfit your estate plan to help them. The accumulation of assets over one’s lifetime can be put to a lot of good after death, if protected the proper way. One thing to consider, is how your assets will be taxed after your death and how that will affect those to whom you are giving gifts. There are several ways to limit the effects of Washington Estate Tax, Capital Gains, and others, such as the Federal Gift Tax Exemption. 

The large Federal Gift Tax Exemption makes lifetime gifting one of the best options for reducing the Washington State Estate Tax. For example, if a single individual had an estate valued at $3 million, their estate could be liable for over $80,000 in Washington State Estate Tax. However, if they were to gift enough during their life to reduce the value of their estate to less than the Washington State Estate Tax Exemption, currently $2,193,000, no estate tax would be due at the time of their death.

While this can be a great strategy for reducing the estate tax, it could increase capital gains tax if the property gifted is a capital asset with a low basis. Returning to our example above, imagine the property gifted was investment real estate valued at $800,000 with a zero basis. A capital gains tax will be due when the recipients sell this property. Depending on the tax brackets of the recipients, the capital gains tax rate could be as high as 23.8%. At that rate, the capital gains tax paid would be $163,040. Twice as high as the Washington State Estate Tax savings.

This doesn’t mean that gifting is a bad strategy. It just means that care needs to be taken on the timing and tax characteristics of the gifting. To illustrate, let’s revise our example.

For our new example, we have a married couple with an estate of approximately $5.2 million. They own the same low-basis property, and their estate planning documents will properly utilize both of their available estate tax exemptions. If they were to gift this property before the death of the first of them, the result would be the same as in the previous example.

However, if the survivor made the gift after the first spouse’s death but before the second spouse’s death, they could avoid both the capital gains tax and the Washington State Estate Tax.

Sounds too good to be true, doesn’t it? This result is possible because the rental property will get a new fair market value basis at the time of the first spouse’s death – meaning the adjusted basis on the property will go from $0 to $800,000. This basis “step-up” works on all capital assets – stocks, bonds, mutual funds, rental properties, and even business interests.

Unfortunately, this “gift-later” technique is not without its own tax risk. The gift might not happen if the surviving spouse is unable to make the gift or the spouses die together. These risks can be addressed through proper planning, including gifting powers in the trust or using insurance in an irrevocable life insurance trust.