Ask Liz Weston

Get smart with your money

step-up in tax basis

Q&A: He’s held stocks for decades. Should he sell before he dies?

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Dear Liz: My father-in-law, age 100, has more than $1 million in stocks and bonds purchased in the 1980s and 1990s. With the stock market so high, I have suggested that he might want to sell the investments, take the tax hit and consolidate into short-term certificates of deposit or similar. This would make it easier for his family to manage (in trust) upon his death. Does this make sense or do we leave it alone?

Answer: Selling now means your father-in-law would have to pay a substantial and perhaps unnecessary tax bill on the gains he’s incurred over the years. If he instead leaves those assets to his heirs at his death, most likely no tax would be owed on the gains.

There are some exceptions, such as if the investments are held in retirement accounts or an irrevocable trust. But investments held in revocable trusts, such as living trusts, should qualify for the favorable step-up in basis that would eliminate the taxable capital gain at his death.

Yes, there’s always a risk that the markets could drop — but they would have to drop pretty far to wipe out all his gains, assuming he’s got a reasonably diversified portfolio. A fee-only, fiduciary financial planner could review the portfolio and offer recommendations about any changes that might be needed, while a tax pro could discuss potential strategies for minimizing the tax bill.

Q&A: Property transfers trigger tax problem

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Dear Liz: I’m considering giving property (a condo) to my child through a quitclaim deed while I am still living. If she continues to live in the condo for two years after gaining possession, doesn’t she get a $250,000 capital gains exemption when she sells the property?

Answer: Yes, if she owns and lives in the home for at least two of the previous five years, she can exclude up to $250,000 of home sale profits from her income. However, her taxable gain would be based on your tax basis in the property: basically what you paid for the home, plus any qualifying improvements. Only if she inherits the home would the tax basis be updated to reflect its fair market value on the date of your death. Although taxes should never be the sole consideration for property transfers, the favorable step-up in basis may be a powerful incentive to hold off. Consider discussing your options with a tax pro.

Q&A: Adding daughter to home could create a tax burden

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Dear Liz: My wife and I are both 80 and we are contemplating adding our 56-year-old daughter as a co-owner and borrower to our home. The house is now valued at $600,000 and our mortgage balance is $196,000.

If it is advisable, and I am able to do this, will it prevent the house going into probate when my wife and I have passed on? Because my daughter will be the sole beneficiary of our assets, is a will or living trust required?

Answer: Please don’t do this without consulting an estate planning attorney — who will most likely tell you not to do this.

You can’t add your daughter to the mortgage without refinancing the loan. Adding your daughter to the deed means she would lose the valuable “step up” in tax basis that would otherwise happen after your deaths.

If she’s made a co-owner, she could be subject to capital gains taxes on all the appreciation that happened on her share. That tax burden essentially would disappear if she were to inherit the home instead.

How you should bequeath the home to her depends on where you live. In most states, probate — the court process that typically follows a death — isn’t that bad.

However, in some states, such as California or Florida, probate can be lengthy, expensive and worth avoiding. It can be worth investing in an attorney to draw up a living trust.

Another option in many states, including California, is a “transfer-on-death” or beneficiary deed, which allows you to sign and record a deed now that doesn’t transfer until your death. You can revoke the deed or sell the property at any time.

Florida doesn’t have transfer-on-death deeds, according to self-help site Nolo.com, but the state offers something similar called an “enhanced life estate” or “Lady Bird” deed.

But again, discuss this with a qualified estate planning attorney before proceeding.