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After reading through information on capital gains tax and estate tax, I read that a heir of an investment does not have to pay capital gains on that investment. That is it's transferred free and clear as long as it's under the $11.2 million inheritance exclusion? Also, a single person is able to gift another person up to $15k/year free and clear, or $30k for a married couple.

With that said, would it then not be possible to regularly gift a trustworthy relative money that they would then invest, and agree to will back to you when they pass (assuming that's before you) which you'd then receive with no tax imposed?

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    Probably the key phrase is "trustworthy relative". You'd need quite a lot to make this worthwhile, and -- since they need to be elderly so they die first -- it's will be a dwindling supply...
    – TripeHound
    Oct 3, 2018 at 9:52
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    What happens to the income (dividends, capital gains, etc) generated by the investment during the lifetime of the trustworthy relative? Who pays the tax on that? Your scheme is of no benefit to you whatsoever.
    – Dilip Sarwate
    Oct 3, 2018 at 10:11
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    Just one man's opinion, I'm surprised at the many comments on here, doubting that one could find a family member to do this. Tight, successful, financially aggressive, families do this sort of thing for each other all the time. Example, I will very likely die before my youngest children, of course I would do this for them and not "rip them off" in doing it - !! (Note, of course, obviously, the tax rule questions are the issue here.)
    – Fattie
    Oct 3, 2018 at 17:05
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    @Fattie Certainly it's possible to have trustworthy relatives, but not all families are tight, successful, and financially aggressive.
    – JAB
    Oct 3, 2018 at 17:41
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    Is this related to the recent New York Times investigation of Trump's tax evasion? If I read correctly, Trump did exactly that in the 90's, which led to this loophole being closed.
    – BlueRaja - Danny Pflughoeft
    Oct 3, 2018 at 18:54

2 Answers 2

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There are some issues with this plan:

  • you have to trust they will do what you want with the money.
  • you have to hope that they won't need it.
  • you hope that the presence of this investment fund doesn't impact their ability to get Medicaid coverage for their long term care needs.
  • they have to die first.
  • you have to trust that their end of life documents don't direct the funds to somebody else, or that the money has to go through probate, or that they have other debts and the funds are used to pay those debts.

A concern is how will they avoid the taxes on the gains that take place during the years they have the investments. As long as the taxes on the gains are lower than your annual contribution, you could direct them to use some of your new money to pay those taxes.

If they still had income from a job they could put that money into a IRA, but that would only work for as long as they had income.

But the biggest problem is that if you put requirements on the money it isn't a gift. The IRS doesn't treat favorably transactions that are designed to use trickery to avoid the taxes.

Sure they could do this on their own, but the fact you are doing this in a coordinated way to skip capital gains taxes would make it illegal.

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    mhoran - there is also a bit of tax code that specifies a timeframe. If the deceased dies within X years, the 'gift' will be deemed reversed, and the beneficiary gets no step-up. I believe (That's me saying 'not sure') it's 2 years.
    – JTP - Apologise to Monica ♦
    Oct 3, 2018 at 13:10
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    I'm confused by "A concern is how will they avoid the taxes on the gains that take place during the years they have the investments." My understanding is that capital gains tax is only owed when the gain is realized, and they'd only be purchasing the investment, not selling, so the person receiving and investing would have no additional tax burden correct?
    – Travis
    Oct 3, 2018 at 13:46
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    If they invest in a taxable fund and that fund has any distributions from dividends or from selling underlying investments then a 1099-DIV will be issued to the owner of the fund. That income will likely be subject to taxes.
    – mhoran_psprep
    Oct 3, 2018 at 13:50
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    @Travis assets receive a "step up" in basis when inherited. So even if this was an investment in some non-dividend-paying stock, there could be some tax benefit, if it weren't illegal.
    – Glen Pierce
    Oct 3, 2018 at 14:35
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    The last sentence says "but the fact you are doing this in a coordinated way to skip capital gains taxes would make it illegal. "
    – mhoran_psprep
    Oct 3, 2018 at 14:52
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Not a good idea. Aside from moral and (as the other answer notes) legal issues, it doesn’t make sense to risk the full capital for the sake of tax on the income it generates.

Assuming you gift $15k a year for 10 years, your capital at risk is $150k. For simplicity, let’s pretend you can plonk it all in your relative’s account on day 1 and get 10% ‘simple interest’ each year. They’d earn $150k over the 10 years, but US tax at even the highest rate is less than 40% (less than $60k). So you’d be risking the principal $150k + after-tax income for less than $60k potential gain. This is assuming the relative doesn’t squander the money or leave it to the cat. Meanwhile, you have no access to those funds.

All told, this is a high-risk play. And we haven’t even factored in properly what happens when the taxman comes knocking.

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