Ever wondered why people don’t just transfer their home titles to their children while they’re alive, rather than waiting until they die after being written into the will? Aside from losing out on the equity of a home or investment property holds – and thereby losing the value of that equity in your retirement years – simply transferring a massive amount of wealth from one person to another without a fair exchange of funds constitutes a gift. And gifts can be heavily taxed, given the right circumstances. You should know everything about giving in California and the tax gift limit.
Understanding the Gift Tax
The gift tax is a federal levy on transferring property or money without something of equal value in return. For example, selling a house for $1 is still considered a gift in the home’s market value minus one dollar. Some states have local gift taxes. California does not, meaning taxpayers in California are only subject to federal gift taxes.
Gift taxes exist for several reasons, mainly to avoid or discourage income tax evasion through gifting. But gift taxes are not absolute. Taxpayers each have an individual annual exemption limit and a larger lifetime exemption limit on gifts made throughout the years. The gift tax rate itself is also variable, ranging from 18 percent at least to 40 percent at most.
Note that gifts are different from charitable contributions. Your gift tax will depend on the taxable value of the gift you’ve made. Making a generous contribution to a Children’s Hospital for nothing in return qualifies as a tax break rather than a taxable action. Gift taxes are something taxpayers must keep up with themselves. The IRS won’t knock on your door and remind you to pay your gift taxes until it’s too late, meaning you may be penalized.
Any gifts made beyond the annual limit require filling out and filing Form 709, the Gift Tax and Generation-Skipping Tax Return, for every year wherein a taxpayer has gifted more than their yearly limit ($16,000 in 2022, $32,000 for married couples filing and giving jointly). However, filling out Form 709 does not mean you must immediately pay gift taxes. Once your gift exceeds the annual limit, it dips into your lifetime exemption limit.
Your lifetime exemption limit is much higher, at $12.06 million in 2022. Like the yearly gift tax exemption limit, your lifetime gift limit is adjusted yearly for inflation. While you need to report any significant gifts or excess gifts to the IRS, you need only pay a gift tax on any gifts exceeding your annual and lifetime limit. That is a lot of generosity.
Local Gift Taxes in California
As we’ve mentioned, California itself has no state gift tax. This means any unequal transaction made with a friend or loved one is only taxed as per the federal government’s gift tax rules, which means:
- If the total value of all gifts made within 2022 is under $16,000, you owe no gift taxes. Likewise, you can double that limit if you make gifts alongside your spouse.
- All gifts made in 2022 exceeding $16,000 must be reported to the IRS via Form 709. But you do not owe gift taxes until depleting your lifetime gift tax exemption limit of $12.06 million (in 2022), or $24.12 million for married couples filing jointly.
Overall, that means you have quite the buffer before you need to start paying taxes on any gifts made to loved ones. However, hold your horses. There are other taxation issues to consider. Asking tax attorneys questions is another great resource for learning about any tax situation.
Capital Gains Taxes
The donor is always liable for gift taxes. This rule means if you transfer property worth over $200,000 and have depleted your exemptions, the recipient will receive the total value of the $200,000, while you are liable for the resulting gift tax sent to the IRS. However, the recipient has other tax problems waiting for them on the other side if they intend to liquidate your gift.
If the property you valued at $200,000 at the time of transfer was only worth $120,000 when you first acquired it, someone must pay capital gains taxes on the value accumulated over the past years of ownership. Any property that appreciates incurs taxes at the point of sale or transfer due to an adjusted basis. Gifting property to your child does not incur capital gains taxes.
But a sale would. If your child turns around and sells their new investment property, they become liable for the estimated capital gains taxes as per the property’s original value when you acquired it. There are a few ways around this. First, your beneficiary can live in their new gifted property for at least a few years.
Selling a primary residence instead of flipping a gift exempts you from capital gains taxes, provided the capital gains are within a limit of $250,000. Based on our calculated values, your beneficiary would have been on the hook for $80,000 in capital gains, well within the limit.
An irrevocable trust can hold property and wealth impartially and allow you to set a new adjusted basis for your property before moving it to a beneficiary or selling it within the trust and utilizing the proceeds to pay out income to your heirs. Alternatively, you can transfer property through a complex trust.
Such beliefs are difficult and costly to create and maintain, however. When you intend to make a significant gift or contribution to a loved one’s business or estate, consider both the gift tax and capital gains taxes.
Annual and Lifetime Gift Tax Exemption and Estate Taxes
A lifetime gift tax exemption limit can make moving around the large property between your loved ones easier without incurring a significant tax liability. But doing so can still come to haunt you in the future. Your lifetime exemption limit is shared with your federal estate tax exemption.
The federal estate tax is the tax paid on any wealth exceeding the exemption limit on your estate when you die. Making too many gifts throughout your lifetime can significantly reduce your estate tax exemption, leaving your estate open to significant taxation. Some states have an additional state estate tax – California does not.
While the current lifetime and estate tax exemption limit is $12.06 million per taxpayer, it was significantly lower before the 2017 Tax Cuts and Jobs Act. It may drop to previous limits following another primary tax law or by 2026 if the current estate tax provisions are not extended or permanently adopted. When making any major taxable gifts, you may want to count on a lower-than-current estate tax exemption. In addition, investigate ways to reduce the size of your estate before death through beneficiary designations, irrevocable trusts, and specialized estate planning tools.