It is a common misconception when a loved one is living but terminally ill that transferring assets to the heirs is an efficient way to avoid probate and estate taxes. Unfortunately, simple mistake can generate significant tax bills. And this is particularly true at this time of uncertainty regarding the estate tax law.

Obviously family dynamics are the primary consideration, but there can also be financial ramifications associated with asset transfers. Transferring an asset to heirs while one is alive can pass on the owner’s cost basis (original cost of the asset including adjustments) instead of receiving the stepped up basis (current value of the asset) at the time of death. For the heirs who received the original cost basis, a significant capital gains tax might be due. For those who received the stepped up basis, the capital gains tax could be zero.

Last year the tax law was very straightforward. The treatment of cost basis and the estate tax exemption limits were spelled out in the tax code. In 2010 there is a great deal of ambiguity about these issues. Currently the federal estate tax is fully repealed and the carry over basis rule applies (with some provisions to protect smaller estates and spouses). The impact of the carry over basis could be quite painful and costly as heirs try to piece together the cost basis of very old and highly appreciated assets.

In the meantime, there is a great deal of speculation that the estate tax will be reinstated retroactively making it a critical year for seeking advice regarding your wealth distribution strategies.