Giving a gift to a future heir is a great way to reduce the estate tax burden on your heirs. As more and more middle class families slide into the estate tax trap designed for the ultra-wealthy, many Americans are gifting portions of their estates to heirs before their deaths. In order to escape the tax burden, gifts need to be given wisely. So what do you need to know about gifting to heirs?
First, the Limits
Tax-free gifts to heirs are limited to $12,000 per donor, per recipient, and married couples can agree to make a joint tax-free gift of $24,000 to a single recipient. That means it's possible to give up to $48,000 to a child and his or her spouse. (These limits increase to $13,000/$26,000/$52,000 in 2009.) Gifts over these limits are subject to taxation and should follow a consultation with your financial advisor.
There is no exception to this rule for holidays or other gift-giving occasions. It doesn't matter if the gift is a Christmas/Hanukkah present, or to commemorate a wedding, graduation, or birthday; the IRS will seek to tax the amount in excess of the limit.
Think Twice About Property as a Gift
From a financial standpoint, it is usually better for your heirs to inherit real estate than to receive it as a gift from a living benefactor. When real estate is inherited from a deceased owner, the property is assigned a current, fair market value for tax purposes, but no capital gains tax is levied on the property's appreciation. If you gift the house directly, your heirs' tax basis will be what you originally paid for the property, setting them up for high capital gains taxes when they sell the property.
What About a QPRT?
Moving a residence to a qualified personal residence trust (QPRT) is an estate planning technique that allows the grantor to get the residence out of his or her taxable estate and freeze the value, thereby reducing later estate taxes. The QPRT specifies a term during which the grantor will continue to live in the residence. At the end of the specified term, ownership of the residence transfers immediately to the specified beneficiary(s). However, if the grantor dies before the term is up, the residence is included in the grantor's taxable estate and no estate tax savings is gained.
QPRTs are usually most effective in instances where there is no remaining mortgage on the residence and when the term of the trust is relatively long. The decision to create a QPRT involves many considerations, including the length of the trust and the federal interest rate at the time the trust is established, so you should consult your estate planning professional to determine if a QPRT is right for you.
There is a litany of tax nuances that can help you and your heirs escape estate taxes, but there are just as many pitfalls that need to be avoided. Do your research and talk to your tax or estate planning professional to determine the best way to gift a portion of your estate to your heirs.