After spending a career helping clients with tax and estate advice, I often see reminders and lessons about my job in the unlikeliest places. In fact, I received an excellent reminder about low-basis gifting strategies (the topic we are addressing today), from a story about one Jimmy McDonald—aka MrBeast, the reigning king of the world’s biggest social media empire.
Mr. McDonald was criticized recently for the practice of…. giving large, life changing gifts to his fans. He has gifted tens of millions of dollars in prizes to his Youtube and TikTok followers (as well as complete strangers), sometimes in the form of cars and other big-ticket items. The criticism he has received for these acts—it’s lonely at the top! —include comments to the effect that the recipients often are not prepared and/or cannot afford to maintain these gifts, or to pay the taxes on them.
That was not the most interesting angle of the story for many readers. But it was the angle that caught my tax-obsessed eye; my colleagues and I are keenly aware that large gifts, however well-intentioned, may not end up working out as envisioned if they are given away without a proper plan in place to manage taxes.
We work with families every day, developing strategies to help them reduce their estate tax burden and position themselves to transfer their assets to heirs or beneficiaries efficiently. The planning options available to families are numerous. Clients can gift a certain amount of assets to family members without triggering gift taxes, thereby reducing their taxable estate; gifts to so-called “dynasty trusts” may insulate gifted assets from estate tax for multiple generations; the list of options goes on.
A fairly common “dilemma” we face with families is the matter of legacy, low-basis assets and how to manage the potentially large tax burden associated with them. Lifetime gifts of these assets offer the benefit of “estate freezing,” and when trust structures like GRATs are used, we can work with clients to move these low-basis assets outside of the client’s estate and ensure that future appreciation and gains will be taxed outside the estate.
There is a fundamental tradeoff between managing one’s estate tax burden and the capital gains tax burden that heirs may face; ultimately, both of these tax mechanisms combine to determine the efficiency of your estate plan. When you gift assets out of your estate, you generally seek to reduce your future estate tax burden, but your low-basis gift may generate a large future capital gain for the recipient if and when they sell those assets. The opposite is true if you keep those assets in your estate—the estate will bear the tax burden of that appreciation, but your heirs will have a lower capital gains liability. The question is always whether one can benefit more from reducing estate tax or capital gains tax liability.
Logically, these strategies generally make sense when the tax burden inside the estate is much higher than outside. And for many years, that was the case for most clients in the U.S., as estate tax rates historically were much higher than capital gains rates. But that “spread” has narrowed in a meaningful way. Federal estate tax rates have fallen, from 55% in the 1980s to 40% today. Further, estate taxes in many states have been outright eliminated in the 21st century; before 2001, all 50 states had an estate tax, but today, there are only 12 (plus an additional six with various forms of inheritance taxes). Moreover, the estate tax rate is effectively zero if an estate is under the exemption amount, which is at an historically high level - $12.92 million for an individual, and $25.84 million for a married couple. Meanwhile, capital gains taxes have risen at the federal level (now at nearly 24% for most of our clients when the additional 3.8% net investment income tax from the Affordable Care Act is considered), and many states impose their own tax on gains, so the marginal tax rate for capital gains often approaches 30%. As a result, gifting low-basis assets during a client’s lifetime has become relatively tax-inefficient in a growing number of scenarios, when compared to retaining those assets within one’s estate.
But don’t look a gift strategy in the mouth! Transfers of low-basis assets in the form of lifetime gifts may still be advisable in some cases. While not an exhaustive list, here are several scenarios in which gifts of low-basis assets may make sense.
When you can retain the income tax liability of the gifted asset. In some situations, you can retain the income tax burden inherent in the gifted asset (both ordinary income tax and capital gains tax upon a sale), even while the economic value of the asset is passed to a beneficiary. A primary mechanism for achieving this result is a so-called intentionally defective grantor trust (IDGT). If you create an IDGT, you are deemed the owner of the trust for income tax purposes, but the trust beneficiary receives the economic benefit of the trust’s assets. If you contribute a low-basis asset to an IDGT and the asset is sold, you will still pay the tax on that sale even though you no longer legally own it. Functionally, this serves as an additional gift to the trust but is not treated as a gift for gift-tax purposes. Essentially, your beneficiary receives a greater net return on the gifted asset than you would because his or her return is not subject to income tax. What’s more, the tax payment reduces your remaining assets and thus lowers your eventual estate tax bill.
When you can discount the fair-market value of the gift for gift-tax purposes. You may be able to discount the value of a gifted asset if the beneficiary will not have administrative control over a received asset and/or they cannot easily sell the asset. Tax law allows discounting in these situations to reflect the lack of control and lack of marketability of the asset. For example, if you hold minority interest in, or nonvoting shares of, a closely held business, you may be able to discount the value of that asset for gift-tax purposes. There are other ways to generate valuation discounts through indirect gifting strategies. For example, publicly traded securities wouldn’t normally be eligible for a discounted valuation, but if you place them in a family limited partnership and gift interests in that partnership to your beneficiaries, you may be able to apply a discounted valuation to the partnership units. Such discounting enhances estate tax savings because the amount of the discount is the functional equivalent of additional post-gift appreciation in the value of the asset. Please don’t try this at home! You need an experienced tax adviser to guide you on whether such discounts are available and how to establish them.
When it is unlikely the transferred asset will ever be sold. If your beneficiary is highly likely to retain the asset, concerns about capital gains taxes become irrelevant—if those gains are never realized they will never be taxed. Accordingly, any asset viewed as a “family legacy,” such as a family vacation home, could be a good candidate for low-basis gifting. Remember, of course, that “never” is a long time, so such plans should only be put in place after ensuring that the recipients truly want to retain the asset, intend to do so, and can afford to do so!
So, as we stated earlier, the gap between estate and capital gains tax rates has narrowed somewhat in recent years; this has made low-basis gifting strategies far less attractive in many cases when compared to simply keeping those assets inside one’s estate and achieving a stepped-up basis at death. But there are also some clear exceptions where it may make sense to consider these lifetime gifts, even when the gifted assets are highly appreciated.
As is always the case in matters of estate planning, your decisions depend greatly on your unique circumstances. Whether you are considering giving a family home to your children or a fleet of cars to one of your Youtube followers, we consider it our responsibility to help you devise a plan that helps you and your family achieve its long-term goals. 
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