How to Avoid the California IRS Gift Tax

California is a state which allows personal residences and other real estate up to $1 million to be transferred to family members without having the property taxes increase.

The IRS is petitioning to review tax-free California tax-free property transfers in the State Board of Equalization’s database from 2005-2010.  Why you ask?  Because even though these transfers are tax-free a gift tax return needs to be filed on those transfers.

Did you transfer property over the last five years?  Did you file a gift tax return?  If not the IRS can come after you with a heft tax, penalties, and interest.

Many transfers will have been into living trusts and other revocable grantor trust set up to avoid probate costs.   These don’t trigger gift taxes.  Other transfers will be of properties worth much less than $1 million by people whose estates will never be worth $1 million, so that even if the gift tax returns had been filed the lifetime exclusion would negate any taxes.

What are gift tax limits?

You may give $15,000 each to multiple people without filing a return.  This is the total amount of all gifts for the year.

From 2006-2008 it was $12,000 and from 2002 – 2005 it was $11,000

From 2011-2012 the lifetime gift tax exclusion is $5 million.

From 2005-2010 the exclusion was $1 million.

Gift tax rates for taxable gifts has gone from 47% in 2005 to 35% now.

The lifetime exclusion is currently (2018) $11,180,000.

So how can you avoid the California IRS gift tax?

Look back and see if you filed Form 709, the gift tax return, on any properties or assets that changed title. Married people need to file this form separately.

Eva Rosenberg is the founder of and an enrolled agent licensed to represent taxpayers before the IRS. See some of her tips below for avoiding the California IRS Gift Tax:

Filing the Form 706 to generate no taxes

You or your spouse can give property worth more than $15,000, but less than $26,000 to each of your offspring or grandchildren. There’s a technique called “gift splitting” where you report part of your spouse’s gift to someone as your gift. IRS explains it in more depth, in chapter 2 of Publication 950.

For instance, you give your nephew $20,000 and your wife gives her sister $18,000. Separately, each of you has exceeded the annual $15,000 limit, right? But, each of you can file a gift tax return reporting half of each gift. It looks more like this:

You gave your nephew $10,000 and your sister-in-law $9,000.

Your wife gave your nephew $10,000, and her sister $9,000.

Discounting is another technique. Bill Fleming, managing director of PwC in Hartford, Conn., explains how to use this when you give someone a partial interest in a property. You can get an appraisal showing a lower value because the recipient of the gift doesn’t have full control of the asset or property. You must still file the gift tax return, but using the lower values will cause you to deplete your exclusion more slowly.

For instance, you give your best friend 10% of a rental property worth $2,000,000. At face value, that gift would be worth $200,000. But he cannot sell his interest without your approval. In fact, he might become responsible for out-of-pocket expenses, without the power to veto those repairs. An appraiser might value his share at only $150,000. How does that affect the gift tax?

You have a tax-free gift of $15,000.

The other $135,000 reduces your $11.180,000 million lifetime exclusion to $11,045,000.

You pay no gift tax

Not using discounting would have reduced the lifetime exclusion by another $50,000. This isn’t so important with a $11,045,000 million limit. But with $1 million, this added up quickly.

This concept can be particularly important when you are going back to transactions from several years ago that actually generate a gift tax. The more restrictions there are on the title or authority to control the asset, the larger that discount will be. Considering a 2005 gift tax rate of 47%, every dollar counts.

These concepts barely brush the surface of the gift-tax issues. When you are making plans — instead of trying to prepare un-filed gift tax returns — you can play with a variety of trusts, charitable contributions and other gifting ideas.

Other states should beware.  After the California audit they may be coming after you.

First-time buyers can still compete against these cash buyers (do not give up hope!), as first-time buyers typically do not have many contingencies

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