Gifting is often discussed as a solution to a variety of matters with estate planning. There are many things to consider when making a gift. Each time a person considers a gift, it is very important to assure they have the complete understanding of the rules and ramifications.
No Minnesota Gift Tax; However, there is a Three Year Look-Back for Gifts Made
First, a note on Minnesota rules. There is no Minnesota state gift tax. However, there is one potential issue with gifting and Minnesota estate taxes. If a person gives assets and dies within three (3) years of making the gift, those gifted assets would be included in the person’s estate for determining Minnesota estate taxes.
Analysis of Federal Estate Tax and Federal Gift Tax, and How they Work Together
Understanding how gifting works first requires an overview of how federal estate tax works. The federal estate tax applies to the transfer of property at death. A federal estate tax return is due within nine months of a person’s death if that person’s gross estate exceeds the exemption amount, which is $11.7 million per person in 2021. The estate tax applies to a decedent’s gross estate, which generally includes all the decedent’s assets – both financial (cash, stocks, bonds, and mutual funds) and real property (homes, land, and other tangible property). It also includes the decedent’s share of jointly-owned assets and life insurance proceeds from policies owned by the decedent. Once you get the taxable estate amount, you apply the year of death’s estate tax credit to exempt against the taxable estate. As stated above, in 2021, the exemption is $11.7 million. Any value of the estate above that amount is generally taxed at the top rate of 40 percent.
How Does the Federal Gift Tax Work?
The gift tax applies to transfers made while a person is living. The law provides a lifetime exemption of $11.7 million per donor (2021). This exemption is the same that applies to the estate tax and is integrated or unified with it, which means that gifts made during life reduce the exemption amount available for estate tax purposes at death. If a person exceeds the $11.7 million lifetime exemption (meaning they give more than $11.7 million subject to their unified credit away in life), then donors pay gift tax at the same top rate (40 percent) that applies for estate tax purposes. There is an annual gifting allowance as well, which does not have an effect against the lifetime exemption. This exemption is $15,000 (in 2021) per person, granted separately for each recipient. In other words, a married couple with two children could give each child a total of $30,000 each year ($15,000 per parent to each child) without owing gift tax or counting toward the lifetime exemption. If you exceed the annual gifting allowance, you must file a gift tax return, and that amount applies to your unified credit, as described above.
What Can you Gift?
You can gift cash, personal property, stock, land, grain, machinery and equipment, interests in business entities, among other things. Although you can gift whatever you want, there are three very important questions to analyze when determining what you gift:
- What is the value of the asset gifted (real estate needs appraisal);
- How can you assure that the gift was completed properly; and
- What is the income tax basis of the gift?
Determining Value of Gift
Valuing the gift is a crucial part to the process. How the gift is valued depends on the type of asset given. Clearly, cash is valued at whatever amount is gifted. If the asset gifted is grain, stock, or anything traded on a public market, the value of the gift is whatever the value is for the date given. The value of a gifted asset for which a value is not readily available on an open market requires additional work. For example, if a person gifts another person an interest in real estate, the way to determine the value of the gift is to get the real estate appraised by a qualified appraiser.
Assuring the Gift is Properly Completed
The next matter is assuring that when a gift is made, it is properly completed. If you give grain or stock in a company, you need to go through the proper channels, i.e. documentation with the elevator, investment broker, to assure that the gift is properly given. Titled vehicles are given when the title is transferred. Machinery and equipment/other personal property without a title is given when a bill of sale or document transfer notice is completed and provided by the giver to the receiver. In order to properly complete a gift of real property, you need to complete and file a deed with the county recorder.
Determining the Income Tax Basis of the Gift
The third matter to address when making the gift is to assure that the income tax basis is properly determined and accounted for going forward. This is important, as the gift may be tax-free when the gift is complete; however, that doesn’t mean it is income tax-free. Depending on the type of asset gifted, the recipient may have income tax ramifications. The starting point here is understanding a carry-over basis. When a person makes a gift, he does so with the reality that the tax basis of that asset in the hands of the giver “carries over” to the recipient. If the recipient later sells the asset (like grain, for example) the recipient’s income tax basis is the same as the giver’s, and the recipient is now liable for the income tax as a result of the sale.
Additional consideration and understanding must be had regarding gifting depreciated assets, such as machinery and equipment. If a giver gives ownership in machinery and equipment, the basis in that equipment gets transferred from the giver to the recipient. Assets that are depreciable usually have a low basis or zero basis once they’ve been fully depreciated. When that asset is gifted, the recipient takes that asset with the low/zero basis. If the recipient later sells that gifted asset, he will have to “recapture” the depreciation as a result of that sale and count it as taxable income.
What about real estate? Real estate is the same with respect to basis – there is a carry- over basis. For example, suppose a person owns a parcel of land that he originally bought for $100,000. The current fair market value of this parcel is $1,000,000. If this parcel is gifted, the basis in the hands of the recipient is $100,000, which carries over from the giver’s basis. If the recipient later sells this parcel, he will have a gain based on the original basis (carry-over) of $100,000 and whatever the sale price is – in this example, presumably $1,000,000. Thus, there would be a taxable gain of $900,000 in this example.
In closing, gifting can be an effective tool in estate planning. There are many factors to consider when making a gift. It is important to work with your legal and tax professionals when considering this tool. Our Succession and Retirement Planning Department can help you with this. Talk to your local AgCountry branch for more information.