Gift Planning: How to Best Structure Gifts of Land, Cars, or Insurance (Part 1)
Gifts made during your lifetime will reduce the size of your taxable estate, depending on your state’s taxes and death duties, after you’ve passed on. But by reducing the size of your estate, there may be savings in probate-related expenses and federal estate taxes. While there are a few states that impose an inheritance tax on a dead person’s property, Oklahoma is not one of them. Oklahoma doesn’t collect an estate tax either, under certain conditions.
Generally speaking, an inheritance is not considered income, and so you won’t have to report it on your state or federal income tax returns. There are exceptions to this, such as with inherited IRAs and taking distributions from them, but that’s not within the scope of this article.
Most estates are simple, and don’t require the filing of an estate tax return; a filing is required, in 2018, for estates with combined gross assets and prior taxable gifts that exceed $11,180,000.00. It’s interesting to note that only two percent of estates in the U.S. are required to file estate tax returns. Reducing estate tax obligations is one advantage to gifting; another is that income tax savings can be realized by shifting income-producing property from one family member to another who is in a lower tax bracket. Some people gift money, some people gift land, or cars, or insurance.
Gifting A Home/Land
If your estate is below the 2018 tax exemption amount of $11,180,000, your best strategy may be to live in your home until you die. Why? Because when you die, your home’s tax rate will be assessed at fair market value as of the date of your death, which means your heirs won’t pay capital gains taxes on appreciation. And with the value of your estate being below the tax-exemption amount, your heirs will owe no federal estate taxes; this means they’re free to move in or to sell it.
When selling a house that’s been inherited, if your heirs inherit a house that is valued at $200,000.00 on your date of death, and they sell the house for $300,000.00 later, your heirs will owe capital gains taxes on the $100,000.00 profit.
But let’s say that your parents, or someone else, wants to gift you a home, or land, while they’re alive.
A gift is made at the giver’s cost basis, which is typically the market value of the home or property at the time of the gift. Let’s say you want to give four acres of land to a family member, and each acre has a value of $500.00; this makes the cost basis, or fair market value, $2,000.00. If the decision of the gift recipient is to sell the land later on, for $8,000.00, the long-term capital gain will be $6,000.00.
Gifting Your Home But Maintaining Residency
If you want to catch the (negative) attention of the IRS, then this strategy is for you. So how do you avoid running afoul of Uncle Sam if this is your ideal scenario? The cleanest way to do this is to make a seller-financed, full-market-value sale to your child, and then rent the property from your child at the market rate. Always take care to pay market-level rent to your child. You still have the option to make $14,000 annual, tax-free gifts to your child. But keep those tax-free gifts completely separate from your dealings regarding the sale or rental of the house. Don’t muddy the waters by “forgiving” payments on the note you’re holding for your child, and never include gift amounts when you pay your “rent.”