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Retired Military Finances 401: Protecting Capital Losses Thumbnail

Retired Military Finances 401: Protecting Capital Losses

Taxes Estate Planning

I often say that your motivation to donate to charity shouldn't be the tax code. But, if you're going to donate to charity, you should get the most out of the Tax Code that is allowed. Along the same line, preserving the economic value of capital losses when death is relatively imminent may not be the most important thing to attend to, but it can provide a benefit to someone who needs it. Here is why.

Upon death, basis in capital assets (stocks, bonds, real estate, business) "step" to the Fair Market Value (FMV) upon date of death. This is normally called "step-up" as the FMV on date of death is typically higher than the original basis if the asset has been held for some time. This is generally a "good deal" as the profit on a subsequent sale is based upon the new basis (FMV on date of death). But it isn't always the case. In some circumstances the FMV on date of death will be lower than the original basis. In this case, the profit on the future sale will be higher than the profit based on the original basis. In fact, money that is a return on losses during the original owner's life become a taxable gain. There is another way though.

Gift Assets With Capital Losses

If it becomes apparent that death will occur before the asset will return to or exceed its original purchase price, it might be a good idea gift the asset to a person who would inherit it anyway. That is because basis on gifted assets is not (generally) affected by the FMV on the date of the gift. Another way to say that is that gifted assets maintain their original basis (or owner's basis). So in effect, the person who receives the gift, also receives the potential losses that can be deducted (within limits) against other income or offset gains when the gifted assets are sold (presumably at a loss).

The Rules Are Different Depending on Who Receives the Gift

If a spouse receives a gift of an asset that has an embedded loss, the basis of the asset he or she receives is the original basis. It should be noted that inherited basis for a spouse depends on whether the state is common law or community property when it comes to marital assets. Talk to an attorney in your state, to determine how it would apply to you.

This isn't the case if a non-spouse receives an asset with an embedded loss. It gets a lot more complicated and there are 3 scenarios.

  1. The asset is sold for more than the original basis. In this case, the gain is calculated using the original basis.
  2. The asset is sold for less than the FMV on date of gift. Similar to #1, the loss is calculated using the FMV on date of gift.
  3. The sale is for a price between the original basis and the FMV on date of gift. There is no gain or loss.

In scenarios 1 & 2, the capital gains and the resulting tax bill are less than if the same asset is inherited. In scenario 3, the loss is the same as if the asset is inherited.

Military Finances Are Different

While this topic is pretty standard for all taxpayers, that isn't always the case. There are a lot of things in the Tax Code that are different for military members and retirees. Military and Veteran benefits also affect your financial plan. We think you should work with an financial planner that works with these issues every day. If you'd like to chat with us, click on the button below or give us a call.

If you found this article useful, you might like the following blog posts:

Military Finances 301: Timing Inherited IRA Distributions After the SECURE Act

I Gifted More than $15,000. Now What?

Military Finances 101: Inheritance and Estate Taxes. Do You Know the Difference?

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