Q: My wife and I are not rich but we have more income and assets that we will need for the rest of our lives. We have two adult children who live in town and five grandchildren. We enjoy travel, particularly with the family. We always pay for the entire clan when we travel. From June of 2020 to this past March we had one of our children, her husband, and two grandchildren living in our house. My son-in-law was unemployed and they needed the help. My question concerns the gift tax. When we pay for the entire family to travel is there a gift made? Do we have to measure the “fair” rent of living in our home for our daughter’s family?
A: We have a unified system of taxing transfers of wealth. This includes transfers during life and transfers at death. The gift tax covers the former and the estate tax the latter.
A gift, for tax purposes, is defined to be a transfer for less than full and adequate consideration in money or money’s worth.
The focus on “money” in this definition, including the “money’s worth,” relates to the base against which the gift and estate taxes are assessed.
No tax is assessed if you give your family too much love during your lifetime. A tax is assessed if you give them too much money. Property can be measured in “money’s worth,” so a tax may also apply to a transfer of property.
So while John Lennon and Paul McCartney didn’t care too much for money, cause money can’t buy you love, the IRS cares more about the money you give than the love.
To see how the gift tax operates let’s start with the estate tax and work backward. The estate tax applies when you die, and it is assessed on the value of the gross estate minus allowed deductions.
The gross estate includes the stuff you owned at death, measured at their fair value (in money’s worth), and some other things. Other things may be life insurance proceeds if you had certain powers over the policy.
Other things also might include property you transferred during your life, but again with certain powers retained by you. What you owned and what you had power over is cumulated and valued in money’s worth.
As this column is Beatle themed, George Harrison penned, “Now my advice for those who die, declare the pennies on your eyes.” It’s that simple for the Taxman.
The gift tax is the estate tax wingman. It supports the estate tax by making sure that shifting your stuff before you die will also be subject to a “transfer” tax.
Let’s then say that you hear that home values have increased in the hot residential real estate market. You get on Zillow, or some such site, to see what the estimated value of your home is.
The website does not ask if some interloper is living in one of your bedrooms and not paying rent. Your home value is not diminished by family members hanging out in the home.
Once upon a time IRS argued that things like rent-free use of property and even co-signing a loan are gifts. Both items do confer some value on the recipient. They may add to the recipient’s wealth. But they do not take away from your wealth.
The courts have generally held that the gift tax applies when a benefit transfer reduces the transferor’s estate. This reduction has to be in money or money’s worth.
Allowing friends or family to use your property rent-free is showing them some love. It does not reduce the value of your property.
Buying all the groceries, paying for meals, filling their gas tank, and so on, all have monetary value. But the challenge in tracking and reporting such transfers leads to a “practical” rule that the amounts are simply ignored as taxable gifts (the so-called “Hamill” rule).
Those vacations are a different story. Been there, done that. I know they are costly. Try to track the costs but also remember there seem to be quite a few parties who qualify as recipients and you get $15,000 of unreported gifts each year, per recipient.
James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at email@example.com.