By David M Kendrick, CPA, MST

As part of its ever expanding enforcement and collection efforts, the IRS has taken the initiative to identify unreported "gifting" transactions involving real estate with a focus on transfers between family members. If done properly, gifting property during one's lifetime is a proven estate planning tool that can effectively transfer ownership and reduce the overall taxable estate.  However, gifts in excess of the annual and lifetime exclusions are reportable and may be taxable.

Whenever you make a gift of cash or property to anyone in an amount greater than the $13,000 annual exclusion ($26,000 for those married filing jointly), you should report it on a separate gift tax return.  Gifts that exceed the annual exclusion may reduce the lifetime gift tax exemption amount available for future use and may be subject to gift tax, as stated above.  Last year, Congress enacted the "Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010."  This Act increased the gift tax exemption from $1 million to $5 million, enabling one to gift more during his or her lifetime without being taxed.  The temporary increase will expire 12/31/2012.

One might think, if the gift isnÂ’t taxable why report it?  Reporting becomes important because the estate tax and gift tax share the same lifetime exemption amount.  Generally, every dollar used to exclude gift tax during one's lifetime reduces the amount of estate tax exclusion available when a person checks out on planet Earth.  Unreported gifts have the effect of overstating the available estate tax exemption, something the IRS perceives as a problem.  What the IRS is looking for, (and apparently is finding) are unreported transfers between family members involving little or no consideration that may be subject to the gift tax rules.

This initiative was recently made public when the IRS requested a summons in California courts to gain access to property tax records.  California denied the summons arguing the IRS can readily obtain this information from other sources, however many states have voluntarily handed over real property records to the IRS for investigation with Washington being among them.

Keep in mind that there is no special exception to the rules when making a transfer of any property to a family member.  If the property being gifted is valued at more than the annual exemption, a gift-tax return must be filed.  Even if the transfer falls within the lifetime exemption amount—currently $5 million, it must be reported. Different rules apply to those who are not U.S. citizens. Please contact us for more information regarding this IRS compliance initiative if you feel it may impact you.