Generally, any property can be transferred inter vivos, or during life, to anyone that a tax payer desires.
The question typically revolves around two questions: 1) control and 2) taxes.
Control – The first question is to what extent does the taxpayer making the gift want to retain control over the asset?
First, what is a gift? Typically, a gift is the conveyance, or transfer, of a piece of property to another person. The property might be cash, real property, a business interest, or personal property, such as a book.
A gift is a function of property law and revolves around the concept of ownership rights. When we think of property rights, it may be helpful to think of a bunch of sticks with each individual benefit associated with ownership represented by an individual stick. For example, in the case of an apartment building, the ability to enjoy the rental income is a stick. The ability to rent the property is another stick. The ability to use the property to live in might be another stick. When we break down all the incidents of ownership associated with an apartment building where each discreet benefit is a stick, we recognize that there are a lot of sticks. If we bundle all of the sticks under our arm, we might consider ownership the sum total of all the sticks. In other words, property ownership is like a bundle of sticks. When we make a gift, or a “completed gift,” we give away all of the sticks.
The question of control surrounds whether a taxpayer is comfortable giving away all of her sticks. In the case of an apartment, if a taxpayer gives all of her sticks away, she loses the ability to decide on leasing, selling, or even painting the property. In addition, once all the sticks are given away to the other party, the bundle of sticks is subject to the creditors of the person receiving the sticks. Often times, a taxpayer may not be willing to relinquish all the sticks. To protect the property and the person receiving the property, different strategies may include the use of a trust or a charging order protected entity, such as an LLC.can allow a taxpayer to protect the asset and still provide the benefit of some of the sticks.
Ultimately, a gift is the transference of the rights of ownership associated with the property. A taxpayer may control the process and timing of the transfer through the use of entities such as trusts and LLCs.
Second, what are the tax implications of a gift?
Generally, the person receiving the gift is not subject to tax when receiving an asset via gift. There may be taxes associated with ownership such as property taxes, but generally speaking, there are no gift, income or capital gain taxes assessed against the person receiving the property.
For the person who is making the gift, a bit more analysis is required. Generally speaking, tax is due when assets are transferred between non-spousal individuals. As between spouses there is no tax under the unlimited marital deduction. As between other parties, the Internal Revenue Code provides for two important exemptions available to taxpayers making gifts.
The first exemption is the annual gift exclusion. Currently, a taxpayer may gift $14,000 to as many people as she desires every year without triggering gift tax. The IRS treats gifts under $14,000 as de minimus events. There are no reporting requirements for these gifts.
The second exemption is the lifetime exemption. Currently, a taxpayer may transfer $5,340,000 in assets and avoid tax. Under the current tax regime, the lifetime exemption is indexed for inflation and set to increase on annual basis. Under the lifetime exemption a taxpayer may utilize the lifetime exemption to transfer assets either during life or upon death. In other words, under the current exemption amount, a taxpayer may transfer $2,000,000 in assets tax free during life and $3,340,000 upon her death. In sum, the amount of money that may be transferred is quite considerable without paying a tax.
However, even if an individual or a deceased individual’s estate is less than the $5,340,000 threshold, for transfers greater than $14,000 to any single individual in a calendar year, an IRS Form 709 must be filed to provide notice to the government as to the gift and that a portion of the life time exemption is being utilized. Failure to file can impact the tax picture later in life in addition to subjecting the taxpayer to current penalties associated with failing to file the return.
In conclusion, a taxpayer can transfer a home to a child. How it is done may have dramatic impact and is often done through alternative gifting mechanisms such as trusts and entities, such as LLCs. Depending upon the value of the asset, the gift may have certain reporting requirements as well to avoid current and long-term tax issues.
Don Sweet, Esquire AEP headead of the Bay Area offices of Rodnunsky & Associates regularly assists clients in structuring gifts transactions in a manner that satisfies protects control and preserves tax efficiency. Don can be reached at 415-746-9542.