Tax-Smart Ways to Gift Highly Appreciated Assets

If your estate-planning goals include transferring wealth to future generations or creating a charitable legacy, using highly appreciated assets to achieve those aims can help generate substantial potential income and estate tax savings in the process.

In most cases, transferring such assets to a family member or charity allows you to avoid paying capital gains taxes on the appreciation (your heirs will be subject to capital gains tax when they sell the holding) which for long-term holdings is taxed at up to 20%, plus an additional 3.8% net investment income tax if your income exceeds certain thresholds. Furthermore, gifting these assets removes any future appreciation from your estate.

Here are some popular ways to transfer highly appreciated assets for maximum tax efficiency. 

There's a limit on how much you can gift to family members and others over your lifetime with no gift tax consequences. The federal gift and estate tax exemption is $13.61 million per person ($27.22 million for a married couple) in 2024 and $13.99 million ($27.98 million for couples) in 2025. However, if Congress doesn't renew key provisions from the Tax Cuts and Jobs Act of 2017, the exemption may be cut in half starting in 2026 (with a new administration coming in, significant tax changes may be in store).

Estates that exceed the exemption limit may be subject to estate taxes up to 40%—but transferring highly appreciated assets to heirs before you pass can help reduce your taxable estate. To do so in a tax-smart manner, consider:

• Outright gifting: In 2024, the IRS allows you to gift up to $18,000 per person (it increases to $19,000 in 2025) without utilizing part of your lifetime exemption or being required to complete a gift-tax return. As a couple, you and your spouse could give each of your children and grandchildren $36,000 this year with no hit to your estate tax exemption. And if you institute a regular annual gifting strategy, you could meaningfully reduce your taxable estate over time.

  However, unlike assets passed down after death, assets that are gifted carry over your original purchase price (carry over basis) and holding period. If and when your heirs decide to sell the stock, they will incur capital gains on the appreciation from the date of your purchase to the date of their sale. That said, the inheritor's taxes may be lower than yours if they're in a lower tax bracket, so this option might be worth considering if, say, the gift is for a new graduate or other lower-income family member.

• Upstream gifting: Gifting a highly appreciated position to older family members could also be an option if their estate isn't large enough to exceed the estate tax exemption. With this strategy, known as upstream gifting, you transfer appreciated positions to your parent, who benefits from any income the assets generate before ultimately leaving the asset to your children or other selected beneficiary. When they eventually inherit the asset from your parent, they will receive the step-up in cost basis.

  This strategy uses part of your lifetime estate and gift tax exemption to facilitate the transfer, but it removes future appreciation from your estate.

• Establishing a trust: A grantor retained annuity trust (GRAT) is another method of removing future appreciation from your estate while passing assets to your beneficiaries tax-efficiently. They are often used for gifts to children but not grandchildren because GRATs are not necessarily exempt from generation skipping taxes.

  Under this strategy, you transfer highly appreciating assets into a fixed-term, irrevocable trust, which then pays you annuity payments plus a rate of return (as determined by the IRS) for a set number of years. At the end of the term, any excess appreciation (i.e., if the investment return of the GRAT is greater than the IRS interest rate) of the assets passes to your beneficiaries tax-free and, depending on how you structure your GRAT, the gift may not count against your lifetime gift and estate tax exemption. Keep in mind that your heirs will maintain the original tax basis you had.

  If you die before your GRAT term ends or the assets don't grow as much as expected or lose value, little or no assets will be transferred and the value of the remaining assets, including any earnings, will be included in your taxable estate.  

If philanthropy is a priority for you, donating long-term highly appreciated stock and other holdings directly to a charity can make your donated dollars stretch further because of both the income and estate tax advantages.

For one, doing so allows you to avoid the capital gains tax you would owe if you sold the asset first and then donated the proceeds. Plus, you may also be able to deduct the donated investment's fair market value in the year of the donation up to IRS limitations.

To get this favorable tax treatment, you must have held the asset for longer than a year. Also be aware that the deduction for non-cash donations is capped at 30% of your adjusted gross income (AGI), versus 60% of AGI for charitable donations made in cash. If your deduction exceeds 30%, you can carry over and deduct any excess amount for up to five additional years.

Let's say you paid $100,000 to purchase a stock that is now valued at $750,000—a gain of $650,000. Here's how the tax savings compare for selling the asset first versus donating it directly to charity:

Several vehicles can help implement this tax-smart strategy:

• Donor-advised fund: These charitable accounts have no setup costs, low to no minimum contributions, and relatively low administrative fees. You can contribute your highly appreciated stock or other investments for a deduction in the current tax year, but you don't have to immediately decide which charities will benefit from your gift.
• Charitable remainder trust: You can donate your highly appreciated position to this type of irrevocable trust and you or your heirs receive an income stream for a dedicated term (not to exceed 20 years), after which the remaining trust assets go to your charity or charities of choice. You get an immediate charitable deduction on the value of the assets estimated to pass to the charity at the end of the trust term.
• Private foundation: These are federally recognized charitable tax-exempt organizations that allow families and others to create and manage a legacy of charitable gift-giving for generations to come. Establishing a private foundation is a complex endeavor with differing tax deductions and implications, so be sure you're prepared for the related time and expense involved.

These are just a few of the many ways to potentially maximize your gift-giving while reducing the income and estate tax bite of your most appreciated investments. Having clearly defined giving strategy helps you manage estate tax risks, regardless of changes in estate tax limits across administrations. A financial or wealth consultant can help you approach your decision with your comprehensive financial situation in mind.