Deciding whether you should gift a significant asset to an heir during your life or after your death has typically involved weighing potential estate tax costs against capital gains taxes that would be due when the asset is sold.
You can make annual gifts, up to $13,000 in 2009 ($26,000 if the gift is split with your spouse), to any number of individuals without paying federal gift taxes. There is also a lifetime gift exemption of $1,000,000 ($2,000,000 if the gift is split with your spouse). The basis of any gift made during your lifetime equals your basis plus any gift taxes paid on the gift.
The estate tax exclusion is $3,500,000 in 2009, with a 45% estate tax rate. The basis of any asset is distributed to heirs after your death is stepped up to fair market value on the date of your death. With such a large exclusion amount, you can transfer assets with fairly significant values to heirs without paying estate taxes, while still stepping up the basis to fair market value. However, keep in mind that the estate tax will be repealed in 2010 with special rules in effect for basis adjustments. In 2011, the estate tax will be reinstated based on 2001 tax laws, with a $1,000,000 estate tax exclusion amount.
Thus, when making gifts, you have historically had to evaluate whether it was better to make the gift after death so your estate will pay estate taxes on the value or during your lifetime so your heirs will pay capital gains taxes when their asset is sold. With much larger exclusion amounts, many individuals do not need to focus on estate taxes. Instead, gifts should be made in a manner that will reduce overall income and capital gains taxes for the family.