With the holiday season upon us, the spirit of giving is in full force. Besides being a good way to celebrate this year’s festivities, gifting property can also be an important estate planning tool. There are many benefits to gifting property, such as reducing your taxable estate, transferring tax obligations to your children who may be in a lower tax bracket, or making your estate smaller to avoid probate. Additionally, lifetime giving will provide you with the opportunity to bring joy to others while you are still alive. There are, however, a number of potential pitfalls for the unwary benefactor. A careful review of the current law and your own financial situation can help you determine if you should be gifting property to aid your estate planning goals.
Under federal law, gift tax and estate tax are intertwined. Estate and gift tax rates are applied to cumulative transfers made during one’s lifetime and at death. As of January 1, 2022, the federal estate and lifetime gift tax exemption amount is $12.06 million, or $24.12 million for a married couple. However, certain gifts do not count toward this tax exemption amount, including: gifts to charitable organizations, gifts to U.S. citizen spouses, gifts under $16,000 per year per recipient ($32,000 for a married couple), and direct payments of educational or medical expenses. For gifts over $16,000, or $32,000 for a married couple, that do not meet any of the other exceptions, the person giving the gift will have to file a gift tax return (IRS Form 709). Once you die, your 709 Forms are added up and the total amount of gifts in excess of the annual exclusion amount are added back into your estate, increasing the size of your estate, to determine if any federal estate tax is due.
Under Minnesota law, there is no gift tax. However, Minnesota imposes a tax on the estates of individuals who are residents of the state when they die or who own tangible property (typically real estate) in Minnesota when they die. A Minnesota estate tax return must be filed by a person with an interest in property located in Minnesota if a federal return is required or if the total estate (not just the Minnesota property in the estate) exceeds $3 million. Unlike the federal estate tax exemption, the Minnesota estate tax exemption cannot be transferred between spouses, meaning you cannot combine both spouses’ Minnesota exemption to avoid paying Minnesota estate tax. Additionally, for property located in Minnesota, the value of gifts in excess of the federal annual exclusion amount made within three years of the deceased person’s death will be added back into the deceased person’s estate to determine if Minnesota estate tax is due.
Due to the high estate tax exemption amounts under federal and Minnesota law, you may be questioning the value of making lifetime gifts. However, there are reasons to gift property even if your estate does not exceed the estate tax exemption amounts. To begin with, the current estate tax exemption amounts may be reduced in the future. The current federal estate tax exemption sunsets in 2025, and the exemption amount will drop back down to the prior law’s $5 million cap, which when adjusted for inflation is expected to be $6.2 million. The legislation for President Biden’s Build Back Better Act initially proposed to accelerate the sunset provision, although the present framework of the Act has eliminated this change. Further, gifting property to others may help you transfer tax obligations to your children who may be in a lower tax bracket, reduce your estate so that your inheritors can avoid probate (for Minnesota estates that do not exceed $75,000), and shield property from medical assistance claims.
There are a number of potential pitfalls to making lifetime gifts. When you gift property, the adjusted basis (original cost) of the property remains the same (“carry over basis”). If the recipient sells the property and it has appreciated in value, the recipient will generally pay capital gain tax on the difference between the sale price and your adjusted basis. However, inherited property receives a “stepped up” basis, which is the market value of the property on your date of death. If the value of your estate falls under the estate tax exemption amounts, you may be better off not making gifts of low-basis property to family members while you are alive.
Another potential concern may arise if you end up requiring medical assistance. In Minnesota, there is a 60-month disclosure period on all uncompensated transfers, including gifts (“Medicaid look-back period”). This means that if you give property for less than fair market value within five years of applying for Medicaid, you could incur a penalty period of Medicaid ineligibility. This transfer penalty applies even if the gift is less than the federal annual exclusion amount.
While you are in the spirt of giving this holiday season, you may want to consider gifting property to aid your estate planning goals. As long as you are aware of the potential disadvantages with lifetime giving and you can afford to reduce the value of your estate without impoverishing yourself, gifting property may be a helpful estate planning tool.
Joseph Heck is an attorney at Fryberger Law Firm. He can be reached at Fryberger’s Cloquet office at (218) 879-3363.