Q: Should I gift my house to my child to ultimately reduce the Massachusetts Estate Tax due from my estate?
A: The combination of a high federal gift and estate tax exemption ($13.61 Million in 2024) and no Massachusetts gift tax means that a person could make gifts prior to his or her death to reduce or eliminate the Massachusetts estate tax. For example, if you die with an estate valued at $4,000,000 (including a house valued at $1,500,000), then the Massachusetts estate tax owed would be $180,800. To reduce the Massachusetts estate tax, you could gift the house to your child. Your taxable estate would then be $2,500,000, and the Massachusetts estate tax would be $39,200, resulting in a tax savings of $141,600.
Initially, this strategy seems to make a lot of sense. However, you ignored the capital gains tax. Let’s assume you bought the home forty years ago for $30,000, which will be your cost basis for capital gain purposes. When a donor makes a gift, his or her cost basis in the property is transferred to the donee. Thus, the child’s cost basis in the property will also be $30,000. If your child sells the property shortly after your death, your child will have a capital gain of $1,470,000. The federal capital gains tax (15%) on $1,470,000 will be $220,500, and the Massachusetts capital gains tax (5%) will be $73,500, for a total of $294,000.
By gifting the house, your child lost the opportunity to step up its cost basis. Generally, any asset included in a decedent’s taxable estate gets stepped up to its fair market value on the decedent’s date of death.
Instead, if you retained ownership of the house at death, your child’s cost basis would be stepped up to $1,500,000. Consequently, your child will owe little to no capital gains tax upon sale of the property upon your death.
Here, the most tax efficient approach would be for you to hold onto the house until your death and pay the additional Massachusetts estate. However, if your child has no intention of selling the property, then avoiding the Massachusetts estate tax may be more beneficial.
Before gifting any asset to reduce the Massachusetts estate tax, it is important to consult your estate planning attorney to analyze all tax ramifications to ensure you make the right call.
Know the Law is a bi-weekly column sponsored by McLane Middleton. Questions and ideas for future columns should be emailed to knowthelaw@mclane.com. Know the Law provides general legal information, not legal advice. We recommend that you consult a lawyer for guidance specific to your particular situation.