Let them wait so they get the stepped-up basis rather than the donor’s basis.
I have chosen a practical rather than a philosophical approach to the question. Specifically, what are the tax consequences of giving now versus waiting?
If your children need help, by all means, help them now. You can give up to $13,000 (2009 figure) per child per year without the gift being subject to gift tax. You can give even more, but those amounts will be subject to gift tax. But wait. There is a lifetime tax credit you can apply to gift tax every year until you use up the credit. After the credit is exhausted you will have to pay gift tax on additional gifts. The credit ($345,800 for 2009) is so generous that 99% of us can give it all away and pay no tax.
The credit increases to $1455,800 for estates, that is, after death. In 2010, there is no estate tax at all, only to return in 2011. Nevertheless, the whole question is moot to 99% of us as most of us will never approach the limits.
However, if you are planning to give something other cash, your purpose is probably not financial aid. Anything but cash has various degrees of liquidity. Your children may not be able to liquidate the gift easily, and therefore the monetary value will be unavailable to help them.
Maybe your intent is to plan for your future and your children’s futures. Many people of a certain age find themselves between an uncomfortable rock and hard place. They are too wealthy for Medicaid but too poor to afford a nursing home. Some financial planners advise giving or spending down your assets in order qualify for Medicaid. Be aware that there is a three-year look-back period. If you gave away certain assets during the three years prior to the date you apply for Medicaid, your ability to qualify for Medicaid will be delayed.
Perhaps you intend to give your children an appreciable asset, that is, an asset that increases in value with time. You will want to consider the timing of your gift. You must think about the basis of the gift. Basis means the cost. For example, if you own a house you want your child to have, you have the choice of giving the house either before or after you die.
Say you bought the house for $50,000. That $50,000 is your basis in the house. Your basis as the donor is called “the donor’s basis.” Let’s further assume the house is worth $250,000 today. That $250,000 is called the “fair market value” or FMV.
If you give that house today to your child, you also give your basis. If your child sells the house in ten years for $400,000, the realized gain on the house is the proceeds ($400,000) minus the donor’s (that is, your) basis ($100,000). Your child has realized gain of $350,000. Assuming your child qualifies for the $250, 000 gain exclusion ($500,000 if married), there will be taxable gain of $100,000. If your child does not qualify for the exclusion, the entire $350,000 will be taxable.
But if your child inherits the same house today, the basis is “stepped up” to the fair market value at time of death. In this scenario, the basis of the inherited house becomes $250,000. If your child sells the house in ten years for $400,000, the realized gain is $150,000, not $350,000. If your child qualifies for the exclusion, the gain will not be taxed.
I have just outlined the simplest of situations. There are many rules, adjustments and exceptions. Before you make any decisions, please consult with a tax advisor. See also IRS Publication 950 for more details.