Taxpayers can transfer substantial amounts free of gift taxes to their children or other donees each year through the proper use of this annual exclusion.
The statutory exclusion amount ($10,000) is adjusted for inflation annually, using 1997 as the base year. The amount of the exclusion for 2022 is $16,000, and for 2023 is $17,000.
The exclusion covers gifts an individual makes to each donee each year. Thus, in 2023, a taxpayer with three children can transfer a total of $51,000 to his or her children every year free of federal gift taxes. If the only gifts made during a year are excluded in this fashion, there is no need to file a federal gift tax return. If annual gifts exceed $17,000, the exclusion covers the first $17,000 and only the excess is taxable. Further, even taxable gifts may result in no gift tax liability thanks to the unified credit (discussed below). (Note, this discussion is not relevant to gifts made by a donor to his or her spouse because these gifts are gift tax-free under separate marital deduction rules.)
Gift-splitting by married taxpayers. If the donor of the gift is married, gifts to donees made during a year can be treated as split between the spouses, even if the cash or gift property is actually given to a donee by only one of them. By gift-splitting, therefore, up to $34,000 in 2023 can be transferred to each donee by a married couple because their two annual exclusions are available. Thus, for example, a married couple with three married children can transfer a total of $204,000 in 2023 to their children and the children’s spouses ($34,000 for each of six donees).
Where gift-splitting is involved, both spouses must consent to it. Consent should be indicated on the gift tax return (or returns) the spouses file. IRS prefers that both spouses indicate their consent on each return filed. (Because more than $17,000 is being transferred by a spouse, a gift tax return (or returns) will have to be filed, even if the $34,000 exclusion covers total gifts. Please contact me regarding the preparation of a gift tax return (or returns), if more than $17,000 is being given to a single donee in 2023.)
The “present interest” requirement. For a gift to qualify for the annual exclusion, it must be a gift of a “present interest.” That is, the donee’s enjoyment of the gift can’t be postponed into the future. For example, if you put cash into a trust and provide that donee A is to receive the income from it while A is alive and donee B is to receive the principal at A’s death, B’s interest is a “future interest.” Special valuation tables are consulted to determine the value of the separate interests you set up for each donee. The gift of the income interest qualifies for the annual exclusion because enjoyment of it is not deferred, so the first $17,000 (in 2023) of its total value will not be taxed. However, the gift of the other interest (called a “remainder” interest) is a taxable gift in its entirety.
Exception to present interest rule. If the donee of a gift is a minor and the terms of the trust provide that the income and property may be spent by or for the minor before he or she reaches age 21, and that any amount left is to go to the minor at age 21, then the annual exclusion is available (that is, the present interest rule will not apply). These arrangements (called Code Sec. 2503(c) trusts because of the section in the Internal Revenue Code that permits them) allow parents to set assets aside for future distribution to their children while taking advantage of the annual exclusion in the year the trust is set up.
“Unified” credit for taxable gifts. Even gifts that are not covered by the exclusion, and that are thus taxable, may not result in a tax liability. This is so because a tax credit wipes out the federal gift tax liability on the first taxable gifts that you make in your lifetime, up to $12,060,000 in 2022 and $12,920,000 in 2023. However, to the extent you use this credit against a gift tax liability, it reduces (or eliminates) the credit available for use against the federal estate tax at your death. Feel free to contact us if you wish to discuss this area further or have questions about related topics.
Under these rules, up to $250,000 of the gain from the sale of single person’s principal residence is tax-free. For certain married couples filing a joint return, the maximum amount of tax-free gain doubles to $500,000.
Like most tax breaks, however, the exclusion has a detailed set of rules for qualification. Besides the $250,000/$500,000 dollar limitation, the seller must have owned and used the home as his or her principal residence for at least two years out of the five years before the sale or exchange. In most cases, sellers can only take advantage of the provision once during a two-year period.
However, a reduced exclusion is available if the sale occurred because of a change in place of employment, health, or other unforeseen circumstances where the taxpayer fails to meet the two-year ownership and use requirements or has already used the exclusion for a sale of a principal residence in the past two years. A sale or exchange is by reason of unforeseen circumstances if the primary reason for the sale or exchange is the occurrence of an event that the taxpayer does not anticipate before purchasing and occupying the residence. Unforeseen circumstances that are eligible for the reduced exclusion include involuntary conversions, certain disasters or acts of war or terrorist attacks, death, cessation of employment, change of employment resulting in the taxpayer’s inability to pay certain costs, divorce or legal separation, multiple births from the same pregnancy, and events identified by IRS as unforeseen circumstances (for example, the September 11 terrorist attacks). The amount of the reduced exclusion equals a fraction of the $250,000/$500,000 dollar limitation. The fraction is based on the portion of the two-year period in which the seller satisfies the ownership and use requirements.
These rules can get quite complicated if you marry someone who has recently used the exclusion provision, if the residence was part of a divorce settlement, if you inherited the residence from your spouse, if you sell a remainder interest in your home, if there are periods after 2008 in which the residence isn’t used as your (or your spouse’s) principal residence, or if you have taken depreciation deductions on the residence. Also, the exclusion does not apply if you acquired the residence within the previous five years in a “like-kind” exchange in which gain was not recognized.
Let us know if you have any questions about the exclusion or would like additional information. We are happy to go over the specifics of your situation with you to determine whether a sale of your residence would qualify for this valuable tax break.