IRS has been successful in obtaining records of transfers of real property between family members for less than full consideration from 16 states, most recently California. Such transfers are reportable gifts, and IRS is auditing the transferors to determine if gift tax is due, and demand that gift tax returns be filed. This IRS program again illustrates that using a Quit Claim deed from a family member to transfer ownership to a transferee when company policy requires that the transferee own the home to qualify for a home purchase program is inadvisable. A purchase can be made from anyone and still qualify for the tax benefits of a qualifying home purchase program under Rev. Rul. 2005-74.
The Full Story:
Today’s tax quote: “[W]e tax generosity within families—even as we encourage people to deduct gifts to strangers.” Allan Reynolds
A recent decision of the U.S. District Court for the Eastern District of California granted the Internal Revenue Service permission to serve a summons on the California State Board of Equalization demanding the names of residents who transferred real property to members of their family for little or no money during the years 2005 to 2010. See, In the Matter of the Tax Liabilities of John Does, No. 2:10-mc-00130. The opinion sheds some light on an ongoing effort by the IRS to identify taxpayers who have made gifts to members of their families without properly reporting them on the Form 709 gift tax return.
For at least two years, the IRS has been engaged in seeking this sort of data nationwide. It has already received information about intra-family property transfers from county or state officials in 15 other states (Connecticut, Florida, Hawaii, Nebraska, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Tennessee, Texas, Virginia, Washington, and Wisconsin. Generally, IRS is seeking this information from offices where deeds are recorded, and transfer taxes or recording fees paid, because in most states property transfers without consideration are exempted from transfer, excise, or stamp taxes and can be easily identified. Why is IRS looking for these transfers?
Under federal law, the transfer of property with less than full consideration is a gift. There is an annual exclusion of $13,000 for gifts to each donee during the year. But gifts over than amount must be reported on a gift tax return. Although there is also a lifetime unified credit that currently excludes from gift tax the first $5 million of lifetime gifts over the annual exclusion, that credit was only $1 million during the years the IRS is looking at. Although the unified credit would shield gifts under that amount from immediate gift tax, it also reduces the amount that may be passed free of the estate tax when the donor eventually dies. That is, reported gifts over the annual exclusion are aggregated over a lifetime, and even if they don’t cumulatively exceed the lifetime credit, they will effectively increase the potential estate tax. Consequently, from the IRS point of view it is important that gift tax returns be filed even if no gift tax is due.
The IRS is convinced that many intra-family transfers of property go unreported, and its ongoing initiative described above is designed to obtain information about those unreported gifts.
There is no penalty for failing to file a gift tax return unless tax is actually due, because the applicable penalties for failing to file, failing to pay, negligence, accuracy, etc, are all calculated as a percentage of the amount of tax underpayment. However, if gift tax is in fact due, the penalties can be substantial. Moreover, if no return is filed, the statute of limitations on assessment never runs, so that the IRS is free to audit the taxpayer forever.
According to IRS statistics presented to the California court, at least 50%, and up to 90%, of individuals who make property transfers to relatives for less than full consideration fail to file gift tax returns. Information obtained from the other states listed above has thus far led to examinations of 658 taxpayers, of whom 238 should have filed gift tax returns but did not do so, and 20 owed substantial tax liabilities.
This IRS program is relevant to a question that sometimes arises in relocation programs. Many relocation home sale policies specify that the home in the departure area must be owned by the transferee in order to qualify for a buyout program, whether that is a guaranteed buyout, or an Amended Value or BVO program. Companies sometimes ask whether, in instances where the home is owned by someone else (usually a parent or sibling) the problem of ownership can be addressed by simply having the record owner make a Quit Claim deed in favor of the transferee.
However, providing a quit claim deed would constitute a reportable gift by the owner who executes the deed unless the transferee pays full value for the interest in the home. As discussed above, a gift tax return should be filed, which may have undesirable tax consequences. For this and other reasons, Worldwide ERC® has counseled that such deeds should not be used to correct ownership. This topic is discussed at some length in the Worldwide ERC® Tax & Legal MasterSource under the topic “Employee Not the Owner,” and in a Mobility LawBlog post on September 12, 2011. A purchase that is not from the transferee still qualifies for all the tax benefits of the IRS position on relocation home sales, and avoids the gift tax and other unfavorable consequences of trying to shift ownership.
The new IRS program makes the undesirability of using the Quit Claim deed even clearer; intra-family transfers for less than adequate consideration are in the line of fire, and may have very unfortunate tax consequences when discovered.
Posted by Peter K. Scott