Chapter 6 - § 6.6 • SELECTING GIFT PROPERTY — TAX CONSIDERATIONS

• Jurisdiction: Colorado

§ 6.6 • SELECTING GIFT PROPERTY — TAX CONSIDERATIONS

§ 6.6.1—Basis

For purposes of determining gain, a donee must use the donor's income tax adjusted basis. For purposes of computing a loss, however, the donee uses the lower of the donor's basis or the value of the gift property on the date of the gift. I.R.C. § 1015. Thus, a gift of high-basis, low-value property usually should be avoided, since the donee would acquire a basis equal to the property's low value, and the potential capital loss to the donor would be lost. On the other hand, a gift of high-value, low-basis property may be used to shift to the donee potential gain on a sale of the property — but inter vivos gifts of highly appreciated property must always be weighed against a loss of the step-up in basis at the donor's death.

Note that to avoid abuses of the step-up in basis by conveyance of property to someone in contemplation of death, I.R.C. § 1014(e) renders the stepped-up basis rules inapplicable where a decedent acquires appreciated property by gift within one year of death, when the same property passes at death from the decedent to the original donor or the donor's spouse. See TAM 9308002.

Historically, estates claimed a certain value for a valuable asset, often lower, in order to minimize estate taxes. Beneficiaries of the same asset would in some cases ignore the estate's determination of value and claim a higher basis, thus resulting in less income tax when there was a sale of the asset in question. In response, Congress in 2015 added I.R.C. § 1014(f) and the IRS issued Bulletin 2016-15, which require that beneficiaries consistently use the value determined by the decedent's estate as their starting income tax basis in an asset. The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, Pub. L. No. 114-41; see also Levine & Segev, "Basis of Property — When the Estate and Beneficiary Do Not Agree," 71 J. Fin. Svc. Prof'ls 92 (June 2017).

§ 6.6.2—Anticipated Appreciation

Where property is expected to increase in value, a present gift of all of the donor's interests in the asset will help to reduce the donor's gross estate for estate tax purposes. Although the gift tax value of the asset will enter into the computation of the donor's estate tax, any appreciation in the value of the asset after the date of the gift will normally escape estate taxation. See generally § 6.3 of this chapter regarding implications of I.R.C. Chapter 14 on gifts of partial interests in property.

When low-basis, high-value assets are given, the potential estate tax savings must be balanced against a loss of the step-up in basis that applies to property owned at death, I.R.C. § 1014, as well as the additional, avoidable capital gain income taxes the donees must pay if they sell the property after receiving it.

§ 6.6.3—Life Insurance

A gift of a life insurance policy will remove the face amount of the policy from the donor's gross estate, while a gift tax is assessed only on the present interpolated cash reserve value, which is usually much less than the face amount. Treas. Reg. § 25.2512-6; see generally Chapter 31 of this Handbook. A gift of a life insurance policy on the donor's life remains subject to the rule of I.R.C. § 2035(d) that such property transferred within three years of the donor's death is taxable in the donor's estate. See § 6.2.2 of this chapter.

On the other hand, the current higher level of available gift tax exclusion gives the opportunity for clients to magnify their gifting with the ability of life insurance to leverage the gift, even if the client will not face an estate tax at death.

§ 6.6.4—Wasting Assets

Wasting assets, such as installment obligations, leaseholds, patents, copyrights, and mineral rights, should probably be retained because their values for death tax purposes are continually decreasing. In addition, a lifetime gift of an installment obligation will accelerate the income taxation of any capital gain otherwise reportable on the installment basis. I.R.C. § 453B.

§ 6.6.5—Valuation Problems

Treas. Reg. § 20.2031-1(b) defines fair market value as "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compunction to buy or to sell and both having reasonable knowledge of relevant facts." Valuation for gift tax purposes is substantially defined the same under Treas. Reg. § 25.2512-1. When valuing a going business, Rev. Rul. 59-60, 1959-1 C.B. 237, is the IRS's most authoritative pronouncement regarding the methods and factors to be considered in valuing the shares of a closely held business for transfer tax purposes. See also § 6.6.7.

Valuation problems and disputes occur often in estate planning. See Rev. Proc. 66-49, 1966-2 C.B. 1257, modified by Rev. Proc. 96-15, 1996-3 I.R.B. 41; Smith Estate v. Comm'r, 57 T.C. 650, acq., 1974-2 C.B. 4. A gift of property that is difficult to value may result in an unexpected gift or estate tax liability if the donor is unable to support the value claimed on the return. See Estate of Berg v. Comm'r, T.C. Memo 1991-279. The complicated generation-skipping rules of I.R.C. Chapter 14 and the IRS scrutiny of aggressive discounting of inter vivos gifts under family limited partnerships and LLCs underscore the crucial need for competent appraisals and valuation reports, and supporting documents and data (see below).

When a gift is made of hard-to-value assets, such as interests in a closely held business or artworks, clients should be advised (in writing) that a Form 709 gift tax return should be prepared and filed, including "adequate disclosure," so that a three-year statute of limitations starts to run for the IRS to challenge the gift or the valuation. I.R.C. § 6501(c)(9).

§ 6.6.6—Appraisal Requirements

Since Rev. Rul. 93-12, the IRS has been interested in the methodology of substantiating the values of transfers for income, gift, and estate tax purposes. The IRS's scrutiny is particularly evident in gifts of art to charity, charitable gifts of property unrelated to the charity's purpose, intra-family conveyances, and where large discounts are claimed. The Pension Protection Act of 2006 created new standards for appraiser certification.

For example, with several exceptions, gifts of property over $5,000, or $10,000 for closely held stock, will require a qualified appraisal or a charitable deduction may be denied. Treas. Reg. § 1.170A-13(c). Exceptions include publicly traded stock, and inventory and vehicles sold by the donee without significant intervening use or material improvement. I.R.C. § 170(f)(11)(A)(ii).

For charitable gifts of art valued over $20,000 or if a claimed noncash gift deduction exceeds $500,000, the appraisal must be appended to the tax return; the same is true if a donor attempts to give personal property "not in good used condition" valued over $500. I.R.C. § 170(f)(11)(D). It is good practice, however, to append a copy of the appraisal to any transfer tax return.

The appraisal document should include the name, address, and other applicable information about the appraiser. The appraiser must affirm that the appraisal was performed on a specific date, that the property was valued as of the date of the gift or death, and that the appraisal was done for income tax purposes, and, importantly, the appraisal must disclose the methodology used in deriving the property value. Treas. Reg. § 1.170A-13(c)(3). Appraisals must also include a statement that the appraiser recognizes that a substantial or gross valuation misstatement that he or she knew or reasonably should have known would be used on a tax document could lead to a civil penalty. I.R.C. § 6695A(b). Generally, appraisals will qualify if consistent with the Uniform Standards of Professional Appraisal Practice set forth by the Appraisal Standards Board of the Appraisal Foundation. Notice 2006-96, 2006-46 I.R.B. 902, § 3.02.

The appraisal must be made not earlier than 60 days...