In working with Wyoming retirees, we are often asked about ways our clients can pass assets on to their children or grandchildren tax-free. We love getting questions like these, and it presents all sorts of planning opportunities.
Frankly, we can’t think of a better gift for your heirs than to pass on tax-free wealth, including land, properties, or investments. Here are some ways this can be done.
Name them as beneficiaries to your Roth IRA
Roth IRAs are great ways to build tax-free wealth over time. We recently wrote about a way to accelerate this wealth-building tool using a tax strategy called Roth conversions. One of the great things about Roths is that withdrawals are tax-free.
But what happens if you pass away and your Roth IRA passes on to your heirs? Fortunately, those Roth funds can pass on to your heirs with the same tax-free status! That’s right–when your heirs inherit a Roth IRA from you, they take money from the Roth IRA completely tax-free as well. Current IRS rules do require inherited Roth IRAs to be fully depleted after 10 years from the original owner’s date of death, but all funds are tax-free to the heir.
Example: James passes away. He named his four children as equal beneficiaries to his Roth IRA. When he died, he had an account balance of $200,000. Mark, one of Jim’s children, inherits his share of the Roth IRA valued at $50,000. Mark has 10 years to completely empty his inherited Roth IRA. Mark could pull out all $50,000 and make a huge down payment on a new truck, but Mark is more savvy than that. He instead invests the funds for 10 years, earning 5% per year. Mark now has over $81,000, which he uses toward a down payment on an investment property…all tax-free.
(Note: As an added tax-free bonus, when Mark decides to sell the investment property, he can instead complete a 1031 exchange into a similar investment of real estate, land, or a rental, and delay any capital gains taxes he earned on his initial investment!)
Just Give it Away
Simply making gifts from your personal assets is probably the most straightforward way to pass tax-free wealth to your kids or grandkids. Sometimes retirees assume that passing on an asset as a gift is always subject to federal estate tax. Not really. There is a lifetime limit to how much you can give, but for all but the wealthiest people in the world, the limit is so huge it will never be met (about $13.99 million per “gifter”).
Example: Tina wins the lottery big time and wants to give most of the proceeds to her sister. Tina could give $13.99 million to her sister tax-free. This would use up Tina’s full lifetime gift exemption, and she will need to report the gift to the IRS, but that’s it.
Obviously the above example is pretty extreme. If you find yourself like most of us and lack so much substantial wealth, you can make tax-free gifts each year and avoid any reporting requirements on top of it. This is called the annual exclusion limit which is $18,000 in 2024. This means you could give $18,000 per year to as many people as you want–kids, grandkids, or complete strangers–and they receive the funds tax-free, and you give them tax-free and don’t have to report anything.
Gifting to minors can be particularly advantageous for them if you’re interested in helping them build wealth. UTMAs are special accounts which you can own, with the minor as a beneficiary. When funds are placed into the UTMA by you they constitute a gift. The funds grow over time, and earnings up to $2,500 per year are taxed at the minor’s tax rate, which when factoring in the minor’s standard deduction rate, usually results in little to no taxes owed. When minors reach the age of majority (18 in Wyoming) the UTMA account becomes property of the child–free and clear.
Make them beneficiaries to your real estate or other investments
There are plenty of cases where you may not be interested in gifting assets to a child or grandchild before you pass away. After all, a gift in the government’s eyes is irrevocable, and once the transfer is completed, it’s all theirs to do whatever they want with it.
Assets passed on to your heirs upon your death, however, present an incredible way to pass on wealth free of capital gains taxes to your heirs.
Many assets, including real estate, stocks, bonds, mutual funds, and certain business interests receive what is called a “step-up in basis” upon your death. The basis of an investment is the cost of acquiring and/or improving the asset. Over time, many assets appreciate in market value. When you pass away and your heirs inherit one of these assets, a new basis is assigned to the asset which is the market value at the date of your death. This is called the “step-up” in basis.
Example: David purchased an investment property 30 years ago for $50,000. This is his basis. Over time the property has appreciated to a market value of $400,000. If David sold the property before his death and gifted the proceeds to his kids, he would owe capital gains taxes on the $350,000 gain ($400,000 market value minus $50,000 basis). This could result in a tax bill of tens of thousands of dollars owed by David. Instead, David could give the property to an heir upon his death. When David dies, the property is assigned a new basis of $400,000 (the current market value). David’s heir could then turn around and sell the property for $400,000 and owe no capital gains taxes ($400,000 market value minus $400,000 basis).
I hope this article has been helpful! We meet many Wyoming retirees searching for ways to maintain a meaningful legacy after they die by passing assets on to their heirs, while reducing taxes owed as well. These are a few common ways to make that happen.
If you’d like help implementing similar strategies, or finding other ways to reduce the lifetime tax burden of you and your heirs, we encourage you to reach out to us.
