Now is a great time to make lifetime gifts of real property. The bottom line, however, is that the IRS is watching, and you should be very careful and get good tax and legal advice before you make those gifts.
As many have written, 2011 and 2012 just might be great years for making lifetime gifts of property due to the recently enlarged federal gift tax exemption, but as Benny Kass points out in a recent piece for the Chicago Tribune about gifting property, there are some fundamentals to be considered.
You likely know that property transfers can be made as outright gifts while you are living or testamentary transfers at your death. One of the key considerations is the income tax consequence.
Lifetime gifting raises the issue of “tax basis,” since "the tax basis of the giver of the property (the giftor) becomes the tax basis of the recipient of the gift (the giftee)." If the property has significantly appreciated in value (and, yes, even in this economy some real estate has appreciated greatly), the recipient receives the same tax basis as the giver. For example, a $100,000 home that has appreciated to $500,000 at the time of its gift still has only a $100,000 tax basis. Further, if the recipient doesn’t own and live in that home for two of the following five years before selling it, then this tax basis will make the ensuing profit from sale a prime target for capital gains upon and other taxes (i.e., the difference between the tax basis and sale price in this example). Whereas, had the giver held on to the property and made the transfer through his will or trust, then the tax basis of the property would automatically “step up” to the fair market value at his date of death.
It can be a tricky arithmetic.
If the recipient is going to turn around and sell appreciated property, then simply gifting the property to the recipient is tantamount to gifting a capital gains tax bill. Perhaps other, more income tax-efficient, transfer options might make more sense.
Regardless, if you decide to gift, you should speak with a qualified attorney to discuss the gifting strategy. You will almost always need to file a gift tax return as well.
Reference: Chicago Tribune (July 29, 2011) “Giving property as a gift requires careful tax planning”