00:00:00
Francisco Sirvent: Good afternoon, everybody. We will get started in just one minute. Hang tight; you’re in the right spot.
Well, hello everybody. I hope everyone’s doing well today. My name is Francisco Sirvent. I am the owner and an attorney at Keystone Law Firm, as well as a financial planning advisor with Lifestyle Planning. Today’s topic is: “Do capital gains disappear at death, and how does that work when you’re thinking about your whole tax situation?”
Taxes are a beast. And here we are coming up to tax season—hopefully, you’re nearly done. I welcome you to this topic. We do these pretty frequently, and if you’re here live, welcome! You get the benefit of having an opportunity to do a little live Q&A at the end before we wrap up. If you haven’t seen another one that we’ve done in the past that you are interested in, we do record all of these. They go onto our YouTube channel, which you can find at youtube.com/keystonelawfirm.
00:06:11
Francisco Sirvent: It’s pretty easy to find, and you can see all the different topics that we’ve done over the last couple of years. There’s a lot out there, and you’re welcome to check those out. Additionally, if you see a future one where you can’t make the live presentation, you’ll be able to catch it over there. It takes us about a week to get them posted to our YouTube channel, so don’t feel like you’re missing out if you don’t get the live version.
Don and Katie Paulsen: [Background noise/exclamation]
Francisco Sirvent: Also, as I just described, we do record these. So, please don’t turn your mic on and say something that you don’t want to be on the recording. The system will capture it, and then it will be on the recording. When we get to the live Q&A session, if you want to ask any questions, just keep them generic. Word them in some way that doesn’t reveal too much about you that you’re not comfortable with sharing on YouTube.
00:07:12
Introduction to Capital Gains
Francisco Sirvent: This topic of capital gains is something we talk about a lot with clients because it affects what happens when their family and loved ones inherit from them. That’s the whole focus of this. I want to give you a little bit of an introduction on how capital gains work just so we have some foundation. I’ll give you some concepts regarding what happens to different kinds of property, different kinds of accounts, and investments when they are inherited. We will talk about which ones are affected by capital gains and which ones are not, as well as some strategy ideas that you should consider when you’re thinking about your own finances and taxes.
I hope you walk out of here with a nugget or two so you can make your situation better, save a bunch of money in taxes, and avoid a couple of really common mistakes we see people make that end up costing their family thousands and thousands in taxes.
00:08:27
Disclaimer and Capital Gains Basics
Francisco Sirvent: Before I get into the content, I have to give the disclaimer. This is not legal advice for anybody’s specific situation. It’s not legal advice, it’s not financial advice, and it’s not tax advice for your specific situation. If you want specific advice, you have to speak with a licensed and qualified professional. You’re welcome to reach out to us if you’d like to.
Just a quick overview of capital gains taxes: The concept itself is that if you buy something for $5 and you sell it for $15, it’s gone up in value. That increase is now potentially taxable, and it’s called capital gains. That’s the gain on the capital you invested. If you bought something for $5 and sold it for $15, $5 is the capital you put in and $10 is the gain.
A lot of things are subject to capital gains. It’s not everything in your life, but a lot of things are: your home, any other real estate investments, or commercial real estate. If you have stocks, bonds, or mutual funds that you own—either physical certificates or shares of publicly traded companies—and you own them in your name or your trust’s name, those are going to be subject to capital gains when you sell.
00:10:07
Francisco Sirvent: Investment property, collectibles, digital assets, and crypto are all subject to the capital gains tax scheme in the United States. People start to realize that capital gains tax rates are actually lower than ordinary income tax brackets. Some people try to shift their investments over to that category because the tax rates are lower, but they’re still going to be subject to some tax. There is a tax on everything, right? This is just one category of those taxes.
The one big category that is excluded from that—it’s not on the chart—is money and investments held within your IRA, your 401(k), your 403(b), or some type of qualified retirement program. You might buy stock in there and sell it for more, but as long as it’s within that account structure, that gain is not going to be subject to capital gains.
00:11:28
Qualified Accounts vs. Standard Property
Francisco Sirvent: So, for qualified retirement accounts, when you’re buying and selling within the account, those are not subject to capital gains taxes. That’s a whole separate tax scheme. When you take money out and make a distribution to your checking account, that is ordinary income tax to you. It’s a whole different ball wax.
But there are a lot of things included on the capital gains side: owning a small business, buying art, or buying gold. If it goes up and you want to sell it, there’s going to be capital gains taxes on it. There’s a big tension between capital gains during your life and what happens after death. During your life, it’s pretty standard, though there are exemptions for certain types of property.
The way it works during your life is that you buy something, and that price gives you your cost basis.
00:12:42
Francisco Sirvent: Now, you might make improvements to it, and that will increase your cost basis. For example, say a house was bought for $100,000 about 30 years ago. It appreciates over time—which is what we want when we buy assets. If the house goes up to $150,000, that means there’s a gain of $50,000. If they sell the house, the taxable gain is $50,000. It’s just your sales price minus your cost basis.
The taxable event only occurs when it’s sold. So far, at the federal level, there’s no capital gains tax unless you sell it. That’s pretty key. There have been some proposals floated to tax capital gains even if things haven’t sold—just because they went up in value—but those haven’t gotten anywhere.
00:13:47
The Danger of Gifting Assets
Francisco Sirvent: Right now, the taxable event is at the sale. The other thing that can trigger a taxable event is if you gift it. If you gift it to somebody, it’s treated differently.
I had one of the worst examples of a big tax bill that was completely avoidable. This involved a gal whose dad had passed years earlier. Mom’s health was starting to decline, but it was nothing serious. She was still living at home and she heard from somewhere that she might be able to protect her home from Medicaid—if she ever needed nursing home benefits—by giving it to her daughters.
00:15:12
Francisco Sirvent: So, she recorded a quitclaim deed and gave it to her daughters. However, she kept living there because it was her home. She ended up not needing nursing home care or Medicaid. When she passed away, the house was owned by the daughters. They ended up coming to speak with me after the mom’s death.
What happened was that because the mom gave them the property during her life, the daughters took over the same basis that the mom had. If mom bought the house for $100,000 and gifted it years later, her basis was still $100,000. On the date of the gift, the daughters became the owners, and their basis was that original $100,000.
00:16:20
Francisco Sirvent: Years later, when mom dies, the daughters want to sell the house. By that point, the house was worth about $450,000. Their gain was $350,000. At a 20% capital gains tax rate, that was a $70,000 tax bill at the federal level, plus Arizona’s state income tax. In total, they paid almost $80,000 in taxes just because mom wanted to avoid a Medicaid issue she was worried about.
All of that tax was completely avoidable. The way you avoid it is by leaving it to them at death.
00:17:36
The Stepped-Up Basis at Death
Francisco Sirvent: By leaving the property to them at death—through a beneficiary deed, a will, a trust, or even probate—it remains mom’s house while she’s alive. Even while the value increases, her basis stays at $100,000. The moment mom passes and the girls inherit the house, the tax code says they get a new basis.
This is the “stepped-up” rule. The basis is stepped up to the fair market value on the date of mom’s death. If they sell it shortly after her death for that fair market value, they will owe zero in capital gains taxes. When I explained this to those daughters, they were banging their heads against the wall. It was a very frustrating, expensive mistake.
00:18:45
Francisco Sirvent: This stepped-up basis at death is one of the key things we make sure people don’t screw up. A lot of people want to gift stuff, add a child’s name to an account, or put their child on a deed. All of these things risk losing that stepped-up basis.
This isn’t just a tax scheme for the wealthy; it applies to everybody. No matter how much money you have, this concept applies across the board. In fact, making this kind of mistake in a smaller estate often has a bigger relative impact.
00:19:51
Francisco Sirvent: To recap: If you do it the right way, and a house worth $100,000 appreciates to $400,000, that entire increase is “stepped up.” You don’t have to file a special election or implement complex legal documents; you just have to own it yourself when you die. Whether it passes through probate, a beneficiary deed, or a trust, as long as you owned it through your date of death, it gets that stepped-up basis.
Your heirs get a fresh start and a giant waiver of taxes. This works on your home, rental properties, stocks, brokerage accounts, crypto, art, and precious metals.
00:21:07
Francisco Sirvent: We’ve talked to clients on our financial planning side who have held certain stocks for a long time. If it weren’t for the capital gains tax, they would have sold them long ago to diversify. But they have so much gain built up that they don’t want to take that big “haircut.” We often tell them they might be better off riding it out and letting their heirs inherit it, because the heirs will get that step-up, eliminate the tax, and can then diversify based on their own plans.
00:22:20
Trust Types and Tax Implications
Francisco Sirvent: There are a few different kinds of trusts that can either help or hurt when it comes to capital gains. We are big proponents of owning everything in a Revocable Living Trust to avoid probate and ensure management during incapacity.
With a revocable trust, you can make changes anytime, and you stay in complete control. At your death, the assets are counted in your estate for federal estate tax purposes. If you are over the current limit (around $14 million), it counts toward that. However, the benefit is that those assets do get a step-up in basis.
00:23:39
Francisco Sirvent: Then there are Irrevocable Trusts. There are two main types to discuss here. The first is a trust where you make a gift into it—perhaps for Medicaid planning or for grandkids—but you design it so that it is still “countable” in your estate at death. If it is still counted in your estate, it still gets the step-up in basis. You aren’t doing it for estate tax planning; you’re doing it for other reasons, like asset protection.
00:24:40
Francisco Sirvent: The other kind is used specifically for estate tax purposes. If you are over the $14 million limit and want to reduce the size of your estate, you might make a gift to an irrevocable trust to move assets out of your estate. The downside is that when you die, those assets do not get a step-up in basis. They aren’t taxed at 40% for estate tax, but the heirs don’t get that fresh start on capital gains.
00:25:52
Common Pitfalls to Avoid
Francisco Sirvent: There are a few big things to avoid. First, remember that IRAs, 401(k)s, and 403(b)s do not get these benefits. Even if you name your trust as the beneficiary, they do not get a step-up in basis. If you want a step-up, the asset cannot be in those types of accounts.
Second is the “step-down” risk. The tax law doesn’t say the basis is always stepped up; it says it is adjusted to the fair market value on the date of death. If you bought something for more than it is worth when you die, your heirs inherit it at that lower value. That is just the reality of the basis adjustment.
00:27:00
Francisco Sirvent: Third, you cannot time these things to take advantage of the step-up if it’s not really your property. I’ve had clients ask if they can gift highly appreciated stock to their elderly parents, let it get stepped up when the parent passes, and then inherit it back. The answer is no. There is a one-year look-back rule. If you gift property to someone and they die within a year, and you inherit it back, you don’t get the step-up. The IRS doesn’t allow strategies that are purely for tax avoidance like that.
00:27:54
Summary and Upcoming Events
Francisco Sirvent: That is the high-level overview for today. I didn’t want to go too deep into tax law, but I wanted to prompt some thoughts on what you need to watch out for.
The most common things we discuss with clients regarding capital gains are rental properties that have appreciated significantly (often through 1031 exchanges) or long-held stock portfolios. There are options to help offset or eliminate gains in those situations.
If you want to talk about this, I offer a quick 15-minute call to look at your “capital gains audit” and give you some ideas. I’ll drop the link in the chat.
00:29:23
Francisco Sirvent: I am happy to open it up for questions now. I’ll hang out for a couple of minutes.
00:30:19
Francisco Sirvent: If you want to pop on your microphone, you’re welcome to. While you’re thinking, I’ll mention our next webinar dates.
On April 8th, we have “Legacy Lockdown: From First Steps to Retirement Funds.” Michelle Dexter will be talking about building a fortress around everything you have—from protecting little kids to shielding retirement accounts from creditors and navigating end-of-life issues.
Then on April 24th at noon, I’m going to be going through the nitty-gritty of what it’s actually like to be a trustee after someone passes away. A lot of people name someone as a trustee thinking it’s an honor, but really, they’ve given them one of the most difficult jobs in the world. We’ll be going through the “boots on the ground” reality of that.
00:32:41
Francisco Sirvent: All right, if there are no further questions, we will let you guys go for the rest of the day. Thank you for joining!
[Transcription ended]
