Are you considering an end-of-year gift? Here’s what you need to know and some potential pitfalls to avoid:

Two levels of gifting

Most are aware of the first level of gifting where the IRS allows an annual gift tax exclusion up to $15,000 per person. However, not everyone is aware of the second level of gifting, which allows you to use all or a portion of your federal estate tax exemption – currently $11.58 million per person. This is actually called your unified tax credit, meaning it’s not only your death tax exclusion but also the amount you can gift away during your lifetime, gift tax free. Gifts that exceed $11.58 million in value are taxed at 40% under current law.   

Use it or lose it?

Never in history has this credit been this high, causing some landowners to contemplate making gifts now. The current $11.58 million exemption is due to sunset on January 1, 2026 to previous levels of $5 million per person (projected at $6 to $6.5 million adjusted for inflation).

It’s possible that congress will change this exemption amount sooner. Lawmakers can move the date or make changes to the tax laws. Hence, the use it now or potentially lose it later mentality.   

Is this a real threat, or just hype caused by the recent presidential election?

Related:Giving thanks: have you considered what your farm is thankful for?

In 2012 we saw a high level of gifting in December as the $5 million exemption at that time was expected to drop to $1 million. It turned out Congress voted to keep the exemption amounts unchanged, erasing the need for much of this gifting. In fact, never in history has our estate tax exemption dropped to a lower level. Yet, never in history has it been this high either. 

Anti-clawback regulation

Can the IRS come back later and tax you on previous gifts? This question was clarified earlier this year when the IRS released anti-clawback regulations stating large gifts now won’t harm you later if estate tax exemptions change.

So put that worry to bed: The IRS will honor what the gift tax rules are during the year of the gift.

Remember to file an IRS gift tax 709 form for any gifts made over your annual $15,000 per year exclusion. This informs the IRS you are using part of your lifetime tax credit now. I am working with one family who made a large gift back in 2012 but did not file the necessary paperwork. Now, their attorney is afraid the IRS could not only come back and tax them on this gift, but also the appreciation in value the farmland experienced during this time period.

Portability

If you are a married couple, whose gift exemption should you use when making a gift? Typically, the instinct is to use a portion of each spouses’ exemption. However, consider this: each spouse makes a $5 million gift now, lowering their lifetime exemption from $11.58 million to $6.58 million. Then, the current exemption sunsets to $6.5 million on January 1, 2026. Now, each spouse is left with only $1.5 million of exemption since they each already used $5 million with prior gifts.

Related:Farmland leasebacks: What are they and how do they work?

Alternatively, what if only one spouse made a $10 million gift? Now, in the same example above one spouse would still have a $6.5 million of exemption and because of the rule called portability, the IRS allows any unused credit from one spouse to port over to the surviving spouse. This assumes a timely filing of IRS form 706 during the nine months the first spouse’s estate is open. A lack of filing will disqualify the use of portability. 

Carryover basis

Be aware that on any land you gift, the current basis in the land also carries over to the new owner. Perhaps this isn’t a concern especially if your family never plans to sell the farmland or the farm already carries a high basis. Otherwise, this is why a high percentage of landowners wait to transfer the land through their estate, so it will get appraised and a new cost basis applied. Many refer to this as basis step-up; however, it can also cause basis step-down.

Other strategies

There are other strategies to consider using, in conjunction with gifting and in some cases avoid the need for gifting all together. I touched on one of these in a prior article in using land entities to create the opportunity for discounting the value of your farmland subject to estate tax. You can also gift discounted land entity units rather than physical land.

Gifting in combination with a land sale is also an effective strategy. You as the seller of farmland may use part of your lifetime exemption to apply towards a discounted sale. A discounted sale price can help manage the capital gain from the sale. Current capital gain tax rates are at historical low levels causing some to consider a land sale now.

It does feel as if some degree of tax policy changes are in our future, so I hope the points mentioned in this article help you weigh the options available for gifting in your farm transition planning.  

Downey has been helping farmers and landowners for the last 20 years with their family farm transition, leasing strategies, finances, and general land consultation.  He is the co-owner of Next Gen Ag Advocates and an associate of Farm Financial Strategies.  Reach Mike at [email protected].

The opinions of the author are not necessarily those of Farm Futures or Farm Progress.