Gifts For A Step-Up In Cost Basis

Can investors with a large capital gain maintain their investment and receive a full step-up in cost basis? There is one technique that may be applied, however, it unfortunately requires a dire occurrence.

When an individual gifts an appreciated investment to another person, the recipient can bequeath the investment back upon the their death. The result of playing “hot potato” with the appreciated investment is a full step-up in the cost basis.

Many issues surround this technique. First, there are gift tax issues if the recipient is not the donor’s spouse. And, a step-up in cost basis is not allowed if the recipient dies within one year of receiving the gift and bequeathing it back to the original donor. This is called the Rubber Band Rule.

An example of the Rubber Band Rule is as follows: Bill gives his terminally ill wife, Beth, his appreciated $1,000 stock purchase that is currently worth $100,000. Beth, who dies two months later, devises the stock back to Bill, who then sells it for $110,000. Because the property was appreciated at the time he gave it to his wife, Bill must now realize a gain of $109,000. Beth’s adjusted cost basis just before her death was a carryover basis of $1,000. The step-up is not allowed because the one-year time frame was not met.

Changing the example slightly will show the optimal effects of this technique. Bill gives Beth the appreciated stock, and Beth dies two years later. She leaves the stock, then worth $110,000, to Jeff in her will. Jeff’s cost basis will be $110,000 because of the resulting step-up in basis and, if sold, would result in no capital gain. The step-up is allowed because the one-year time frame was met; one year had lapsed between the date of the original gift and Beth’s death.

In summary, there is an advantage of gifting low-basis property, if the recipient/decedent lives at least one year after the date of gift. This technique also works if the original donor is not the spouse of the decedent; however, the original gift might use up all or a portion of the donor’s unified credit equivalent for 2001 of $675,000 if it is not covered by the annual exclusion amount of $10,000.

This strategy will not work in every situation, as it is based on timing and the recipient not changing his or her mind about bequeathing the gift.

This is just one of many techniques to consider when planning. As always, contact your Financial Advisor or estate-planning attorney before implementing an estate plan.

Lynn Siewert is the Principal of Advanced Corporate Planning and Branch Manager of the Vancouver, Washington Office of Supervisory Jurisdiction, Licensed through First Allied Securities, Inc. Member NASD/SIPC