The IRS has a new auditing initiative. They are reviewing recorded deeds and transfer tax records in order to find unreported gifts of real estate interests.
The IRS has realized that there is "a pattern of taxpayers failing to file Forms 709" for real property transfers between non-spouse related parties. They estimate that between 60% and 90% of taxpayers fail to file a gift tax return (Form 709) despite having engaged in a transaction requiring a return.
The IRS has launched a "Compliance Initiative" to investigate those taxpayers who have failed to file Forms 709. The government is seeking to capture data from states and counties regarding real property transfers taking place between non-spouse family members for little or no consideration during the period of January 1, 2005 through December 31, 2010.
From 2002 through 2010 the lifetime gift tax exemption was $1 million. Gift transfers during that time frame, if they exceed $1 million in value (either by themselves or added to prior gifts), would have triggered a gift tax. The gift tax isn't the only issue. Lifetime gifts use up the exemption that would otherwise be available at death. Even if no gift tax is due because of a particular transfer, failure to report the gift results in underpaying estate tax later.
If no gift tax return was filed, there is no statute of limitations. Furthermore, if the donor does not or cannot pay the gift tax, there is transferee liability which would shift the burden of the tax to the recipient of the gift.
Many states and counties, including Pennsylvania, have voluntarily released their property data. After all, this information is a public record. California refused. The IRS brought an action in federal court to request a John Doe Summons be served on the California Board of Equalization (CBE). Initially, the IRS request was denied because it can make such a summons only if "the United States cannot obtain the information sought from another readily available source." The court said the IRS made no showing of that fact. However, on resubmission, a federal judge approved the request on December 15, 2011.
Transferring real property to family members is commonly done and for various reasons. It may be to avoid estate and inheritance taxes, to qualify for government assistance or to remove the property from the estate to prevent recovery of government assistance payments.
Whatever the reason, there is a great deal of misinformation on how this works. All sorts of unqualified advisors tell people to transfer their homes, investment real estate, farms, etc. The irony here is that very often a gift of real estate to a loved one is not a good idea from an income tax perspective. Unknowingly, taxpayers transfer property without understanding the gift and income tax implications. Before making any transfer it should be discussed with your tax advisor to see if it really makes financial and tax sense in your particular situation.
For folks with modest estates, sometimes gift tax returns are not filed when a property is transferred. The reasoning is that if no gift tax is due, no federal estate tax will be due; and since all civil penalties are based on the amount of tax due, if no tax is due, there is no risk. However, the problem arises much later when lifetime taxable gifts are aggregated with estate assets to compute the estate tax.
If the gift is near the exemption amount or if the value of the estate is over the exemption amount, failing to file a gift tax return is not only against the law, it is not smart. The gift tax return should be filed to get the 3 years' statute of limitations running and to fix the value of the gift for later calculation of the remaining exemption for the estate tax.
If a taxpayer neglects to file a gift tax return or, when applicable, fails to pay gift tax, the IRS can assess penalties. Similar penalties can apply to incorrectly filed estate tax returns, such as returns that do not report lifetime taxable gifts, as well. In cases of willful neglect or filing a false return, the IRS may pursue criminal charges in particularly egregious cases.
The gift tax is an often misunderstood tax. If you are not sure if you have entered into transactions that require the filing of a Form 709, Gift Tax Return, consult with an estate planning attorney in order to avoid potential interest and penalties.
