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Avoid This Costly Mistake At Death

It’s not exactly a fun thing to think about, but death is an absolute inevitability. When that time comes or more aptly, sometime before that time comes, there are a number of planning strategies that you can implement to make sure that you preserve tax benefits and minimize present and future income taxes for your heirs. One such planning opportunity may present itself if you own an investment with a loss as your time nears. The issue and possible planning options are best explained by example, so with that in mind, consider the following case of “Bob and Betty:”

Bob and Betty are a married couple. 10 years ago, Bob bought 100 shares of XYZ stock, which are still held in his name only, for a total of $50,000. XYZ hasn’t performed as well as Bob hoped, and today those shares are only worthy $30,000. Thus, Bob has a $20,000 unrealized loss. If he sells his XYZ stock, he can also sell other investments with up to $20,000 of capital gains and avoid adding any income to his tax return.

But there’s another complicating matter. Unfortunately, Bob has recently suffered a stroke and his prognosis is not good. Betty, on the other hand “will live to be 150.” With that in mind, Bob is looking to make whatever moves he can now to put Betty in the best possible position after his death.

If Bob dies with the XYZ stock still in his name, his heir, in this case Betty will receive the stock with a basis equal to the value at his date of death. In other words, Betty will receive the stock with a step-down in basis, and the $20,000 of unrealized losses Bob had “built up” before his death will be lost, irrevocably.

To avoid losing out on this tax benefit, Bob has a few choices including:

1) Selling the stock now and using the loss to offset gains he incurs on the sale of other capital gains investments (and up to $3,000 of ordinary income). Note that Bob cannot just “bank” the loss on the couple’s joint tax return, because when he dies, the banked carryover loss would die with him.

2) Bob can gift his XYZ stock to Betty before he dies. If Bob does so, Betty will receive the stock with Bob’s original basis. Therefore, if Bob passes and XYZ stock is still below its cost basis when Betty ultimately sells it, she will still be entitled to a loss.