HomeBusinessThis gift strategy can keep more of your legacy in the family

This gift strategy can keep more of your legacy in the family

Upstream gifting is a tax and estate planning strategy in which highly valued assets are given to someone from an older generation, who in turn leaves the assets to the children of the original owner.

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Estate planning usually involves determining how assets should be passed on to younger generations. But instead of leaving a piece of real estate, a bank account, or a growing stock portfolio to your children, it might be smarter to leave those assets to your parents.

That’s the core of a smart tax minimization strategy known as “upstream gifting,” as Charles Schwab highlighted. The strategy revolves around increasing the basis given to assets inherited by heirs. The idea is to reverse the flow of an estate’s valuable assets from ‘downstream’ – to generations of children and grandchildren – by taking advantage of the shorter life expectancy of older, ‘upstream’ generations.

A financial advisor can be a valuable resource as you plan your estate. Find and speak to a financial advisor today.

Upstream gifting is a strategy to expedite the transfer of highly valued assets to children while limiting the taxes owed on the inheritance.

Instead of giving assets directly to your children while you are still alive or leaving them in your will, you can transfer the assets to a living parent or grandparent. In turn, they leave these assets to your children when they die, preserving the increase in basis and saving your children in taxes.

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However, this tax trick doesn’t work with inherited IRAs or other tax-deferred assets. The same applies if the upstream recipient of the asset has an extremely large estate, Schwab said. However, it can be extremely helpful in reducing the tax burden on highly valued assets and expediting the transfer of assets to children.

A woman and her father discuss her estate plan with an estate planning attorney.
A woman and her father discuss her estate plan with an estate planning attorney.

It’s all a bit complicated, but that’s how the tax strategy works in theory.

Loretta invests $1 million in a stock portfolio that grows to $5 million in value with an annual gain of 5% per year. If Loretta sells the stock now, she will be taxed on the $4 million gain above her $1 million cost basis. If she gives the stock to her son Rich, the basis remains $1 million because the gift was made during her lifetime, giving him no tax benefit. In other words, when Rich sells the stock, he will owe taxes on the $4 million in profits the portfolio generated during his mother’s lifetime.

If Loretta lives another twenty years and leaves the shares to Rich after her death, the shares would be worth $13.3 million. Rich would receive an increase in basis and would not owe taxes on the prior gains. However, this would leave the $13.3 million in assets in Loretta’s estate, potentially triggering expensive estate taxes.

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