Lifetime Gifts
Estate planning is often viewed simply as a way to distribute assets after death — but a commonly overlooked aspect is the strategic use of lifetime gifts. Gifts made during the donor’s lifetime offer several distinct advantages over bequests at death.
Advantages of Lifetime Gifts
- Certainty — a gift given today is subject to today’s known tax rules, not unknown future regulations; it cannot be contested by disgruntled heirs
- Donor satisfaction — the donor has the opportunity to see the gift being used; if the donee mishandles the gift, the donor can alter future plans accordingly
- Creditor protection — gifted property is often insulated from future claims of the donor’s creditors
- Intentional defunding — property given away during one’s lifetime is removed from the taxable estate, reducing both estate taxes and probate costs
- Estate freezing — the gift is valued at current market value for gift tax purposes; any future appreciation belongs to the recipient and escapes estate taxation
- Income shifting — a gift transfers future income from the property to the donee; if the donee is in a lower income tax bracket, the family’s total tax burden may decrease
Disadvantages
Benefits
- Reduces taxable and probate estate
- Removes future appreciation from estate
- May shift income to lower-bracket donee
- Insulates property from donor’s creditors
- Payment of gift tax reduces the estate to be taxed later
Drawbacks
- Once given, the property is gone — irrevocable
- Only suited for those with sufficient capital and income to maintain their standard of living
- Retaining control over gifted property typically eliminates the tax advantage
- Current gift tax may be due now rather than at death
Gift Tax Rules — Summary
Federal Gift Tax — Key Points (2024)
- Only complete and voluntary gifts are taxable. Gifts to a revocable trust are not complete and therefore not taxable gifts.
- The gift tax is based on the current market value of the property when given. The tax is cumulative — the rate reflects total lifetime taxable gifts by the donor.
- The unlimited marital deduction allows tax-free gifts of any size between spouses.
- The charitable deduction allows unlimited gift-tax-free donations to qualified charitable organizations.
- The annual exclusion of $18,000 per donee (2024) allows tax-free gifts per recipient per year with no limit on the number of recipients. Gifts must be of a present interest.
- Married couples may split gifts and effectively double the exclusion to $36,000 per donee. The gifted property must be owned individually by one spouse — jointly held or community property does not qualify for gift splitting.
- Each donor has a lifetime applicable exclusion of $13.61 million (2024) to offset gift tax liability. Out-of-pocket gift tax is due only after taxable lifetime gifts exceed this amount.
- The three-year add-back rule has been eliminated for most gifts. Gifts given on a deathbed are generally not included in the donor’s taxable estate. Exception: gifts of life insurance must be transferred at least three years before death to avoid inclusion in the taxable estate.
- The $13.61M exclusion is scheduled to sunset after December 31, 2025, reverting to approximately $7 million unless Congress acts.
Income Tax Considerations
A critical income tax rule applies to gifts: the recipient’s cost basis in gifted property is the lesser of the donor’s cost basis or the current market value (carryover basis). This ensures the largest possible capital gain when the recipient eventually sells. By contrast, inherited property receives a step-up in basis to fair market value at the date of death.
This difference in tax treatment has important planning implications:
- Appreciated property — if the donor is elderly or ill, it is generally better to keep appreciated property in the estate and pass it as a bequest. The recipient gets a stepped-up basis and avoids capital gains tax on the pre-death appreciation.
- Depreciated property — if the donor wishes to give property that has declined in value, the donor should sell it first (taking the capital loss on their own return) and give the cash proceeds instead. Recipients cannot take advantage of the loss, but the donor can.
Income shifting: By making a lifetime gift, the donor also transfers future income from the property. When the donee is in a lower income tax bracket than the donor, this can meaningfully reduce the family’s overall tax burden. As income tax brackets become more progressive, income-shifting strategies become more valuable. Specific strategies are covered in Module 3.
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