Will Transferring a Deed Trigger a Gift Tax?

Full Question:

My mother has been transferring interests in property (as part of estate planning) to her four children, using updated appraisals and the maximum allowable 'gift transfers' every two years. Unfortunately, they have not been kept current on the deed. Will updating the interests (and recording them), trigger a tax liability ?. Our Corporate accountants have full documentation of the transfers as shown on all tax returns yearly.
04/26/2011   |   Category: Taxes   |   State: Maryland   |   #24721

Answer:

The answer will depend on whether there was any gift tax already paid or owed on the transfers, based on the value of the interests gifted. Please see the annual exclusions table at the link below:

http://wills.about.com/od/understandingestatetaxes/a/historygifttax.htm

The person who makes the gift is the one who is responsible for paying any gift tax that may be due and reporting the gift to the IRS on a gift tax return - IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. The gift tax return and any gift tax that may be owed are due on or before April 15 of the year following the year in which the taxable gift was made.

For the recipient of the gift there won't be any immediate income tax consequences since the gift won't be included as part of the recipient's taxable income. However, the recipient may incur capital gains tax when the gifted property is later sold because of the income tax basis that the recipient will receive in the gifted property.

The rules as to basis in the case of a gift do not allow for a stepped-up calculation and they depend upon whether the basis is being calculated for purposes of gain or loss. For determining gain, the basis is the same as it would have been in the hands of the donor and is called a "carryover" basis. In the above example, if the individual who had acquired the shares of stock for $500 chooses to give them to the recipient as a gift and does not hold them until his death, the recipient takes the same $500 basis as the donor. Therefore, if the recipient sells the shares when they reach $1 million in value, the tax liability would be based on the gain of $999,500. The choice between transferring an appreciating asset by gift and holding it until death can be crucial for purposes of the recipient's income tax liability on a later sale.

Where an asset transferred by gift depreciates to a value below the donor's original cost, the recipient's basis is the fair market value of the asset at the time of the gift. Thus, in the stock example, if the shares that had cost the donor $500 were worth $250 at the time of the gift and had depreciated in value to $150 at the time of the recipient's subsequent sale, the recipient's basis for measuring his loss would be $250, and his loss would be $100. If, however, the stock had been worth $600 at the time of the gift but had declined to $300 by the time of the recipient's subsequent sale, the basis for loss would be the donor's basis of $500 (because that figure is lower than the $600 at the value date of the gift), and the recipient's loss would be $500 less $300.

In the unusual situation where the recipient's selling price is higher than the asset's value on the date of the gift but lower than the donor's cost basis, the recipient will have neither a gain nor a loss. For instance, once again using the stock example and the donor's $500 cost basis, if the value of the shares at the time of the gift was $300 and the recipient sells the shares for $400, (1) there would be no gain because, for purposes of gain, the recipient would have a $500 carryover basis, which would be greater than the selling price, and (2) there would be no loss because the $400 selling price would be measured against a basis of $300, the lower of the asset's value at the time of the gift or the donor's cost basis.

The gift recipient's carryover basis can be increased where the donor has paid a federal gift tax on the transfer. The amount of the gift tax that is attributable to the appreciation in value of the asset as of the date of the gift can be added by the recipient to his carryover basis. For instance, if the donor's cost basis in an asset is $50,000, he transfers the asset as a gift when it is worth $100,000, and he pays a gift tax of $20,000, the appreciation in value ($50,000) accounts for one-half of the asset's value at the time of the gift. Therefore, the recipient is entitled to add one-half of the gift tax liability ($10,000) to his carryover basis, resulting in a carryover basis of $60,000.

Even with such breaks, from the standpoint of the recipient's income tax liability on later sale the disadvantages of making lifetime gifts are clear. Of course, there are situations where the immediate transfer of property is so strongly desired and the consideration of the recipient's later income tax liability is not a priority. Tax savings should not be allowed to overwhelm the basic reasons for the transfer itself.

Gift taxes are taxes that supplement the Estate Tax. Gift taxes are placed on gifts given away to any person while you are still living, so that you may not avoid estate taxes by making gifts of your estate. Any transfer to an individual, either directly or indirectly, where fair market value is not received in return is considered a gift. The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. Generally, the following gifts are not federally taxable gifts:

-Gifts that are not more than the annual exclusion for the calendar year.
-Tuition or medical expenses you pay for someone (the educational and medical exclusions).
-Gifts to your spouse.
-Gifts to a political organization for its use.

There are many manners of accomplishing tax savings, such as a life estate deed, trust, and will. The best method of transfer depends on the income, assets, and circumstances in the situation of each person involved. We are prohibited from giving legal advice, as this service provides information of a general legal nature. We suggest you contact a local attorney or tax professional who can review all the facts and documents involved.

See also:

http://www.irs.gov/publications/p523/index.html