With Christmas just around the corner, gifts are on everyone’s mind, giving and receiving, so it’s a logical time to look at gifts from a taxation point-of-view. I’m not talking about the new game console you got your kids, but rather what the Internal Revenue Service considers a gift for tax purposes. Generally, any transfer to an individual is considered a gift when full monetary value isn’t received in return. By that definition, examples of gifts could be amounts of cash or something more tangible, such as a car or deeded property.
Exceptions to the Rule
The IRS uses the fundamental rule that any gift is a taxable gift, but that’s a general rule with many exceptions. First of all, there’s an annual exclusion amount, and this amount applies to each donee. For the 2017 tax year, the annual exclusion is $14,000, as it has been since January 2013. What this means is that if you give your child a cash gift of $14,000 for Christmas this year, it has no tax impact.
What’s more, if you have three kids and you give them each a gift of $14,000, there’s still no tax impact for anyone, since each donee’s gift is within the annual exclusion amount. This amount rises to $15,000 for the 2018 tax year.
Other exceptions include gifts to cover tuition or medical expenses on someone else’s behalf, as well as gifts to your spouse. Gifts to political organizations are also exceptions.
Gifts and Market Value
When a gift doesn’t qualify under the annual exclusion rule, it’s usually the donor who is responsible for paying the gift tax, though special arrangements can be made under which the donee pays the tax. This is an unusual circumstance, so you should seek the advice of a tax professional before you undertake this kind of arrangement.
The gift tax bases on the fair market value of the gift. The fair market value of cash is straight forward, unless it’s a gift of foreign currency. In that case, it’s typically the value of the currency in U.S. dollars on the effective date of the gift.
When a gift is in the form of goods and services, the idea of fair market value becomes more important. For example, let’s say you’re giving a family heirloom diamond necklace to a child, but you’ve already used up your annual exclusion. You may want to sell the necklace to the child for $1.00 to avoid paying significant gift tax amounts, however, the IRS considers the fair market value of the necklace to be the appropriate amount for the gift tax, so you’re unlikely to get away with the cheap sale angle if you’re audited.
The Resale of Gifts
If you’re the recipient of a gift, there may be tax ramifications downstream if you sell the gift. This usually only affects gifts that appreciate in value, however. If the gift was a car, for example, the market value of the car is likely less at the time of sale, assuming it’s not a collectible or antique. With no gain in value, there’s no tax liability.
If the gift appreciates, then it’s a different matter. For example, stock shares that were gifted at $10 per share, but have since risen to $100 per share create a capital gain for you of $90 per share. If you decide to sell to cash in, then that $90 must be declared as a capital gain on your tax return.
A similar situation arises with gifts of property, though there are some other legal loopholes you could exercise then. Living on a property for two years qualifies you for a capital gains exclusion of $250,000, since it now qualifies as a primary residence. If you’re married, you may be able to double that amount.
There are also strategies if the property is rented out, using a Section 1031 exchange, or you can gift the property to someone else, transferring the tax liability with it. When that someone is a charitable organization, they can sell the property without paying tax on capital gains, and you could receive a deduction for a charitable donation in the amount of the property’s fair market value. That’s a win-win that could brighten any holiday season.