Common Gifts and Factors Influencing Their Value
The American Taxpayer Relief Tax Act of 2012 (the “Act”), enacted on January 2, 2013, ended an 11 year period of uncertainty relating to estate tax exemptions and rates by making the agreed upon exemptions and rates “permanent”. [1]
For those of you who still have the assets and inclination to make gifts in 2013, we offer the following summary to help you identify potential assets to gift and factors influencing the value of the gift.
Brief Background on Gift Tax
IRS defines a gift as “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.”[2] A gift may be taxable or nontaxable. Gifts are generally taxable for IRS purposes except in the following cases:
- Gifts that are not more than the annual exclusion for the calendar year;
- Gifts to a political organization for its use;
- Gifts to charities;
- Gifts to one's (U.S. citizen) spouse; and
- Tuition or medical expenses one pays directly to a medical or educational institution for someone.
Under current law, an individual can transfer up to $5.25 million (as of 2013, and inflation-adjusted) over his or her lifetime without being subject to the gift or estate tax. This is referred to as the basic exclusion. However, an individual can also transfer up to $14,000 tax-free under the annual exclusion.
Types of Gifts
The types of assets that an individual can gift are numerous and diverse. The table below compares some traditional and non-traditional assets that can be gifted outright.
| Traditional Assets | Non-Traditional Assets |
| Cash | Life insurance policies and annuity contracts |
| Publicly-traded stocks and bonds | Patents and other intangible assets |
| Real estate | Promissory notes |
| Jewelry and gems | Qualified conservation contribution [3] |
| Art and other collections | |
| Vehicles such as cars, boats, and aircraft | |
| Other personal property |
In addition to gifting assets outright, an individual can gift a fractional interest in an asset or entity. Examples of fractional gifts include the following:
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Factors that Impact Value for Fractional Gifts
Market prices, cash flow expectations, and risk can obviously affect the value of an asset or business. However, what may not be as obvious are the factors that influence the value of a fractional interest in an asset or business. For example, a fractional interest may be subject to certain discounts for lack of marketability (“DLOMs”) and/or control (“DLOCs”). DLOMs may be appropriate to reflect the lack of a ready market for the interest. A DLOC may be appropriate to reflect the fact that a non-controlling fractional interest cannot manage or control the entity or asset, determine distributions, or force liquidation.
As an example, consider a common gift suggested by estate planners – a fractional, non-controlling interest in an FLP. An FLP will typically be guided by a partnership agreement, which specifies rules and restrictions that apply to its partners. The existence of various restrictions within the partnership agreement can influence the value of such a gift.
Key factors influencing an FLP interest include:
| Factor | Lower Discount / Greater Value | Higher Discount / Lower Value |
| Size of the FLP | Larger, more profitable | Smaller, less profitable |
| Nature of the FLP | More diversified / lower-risk assets | Less diversified / higher-risk assets |
| Leverage | Low debt | High debt |
| Distributions | Large, frequent | Minimal, infrequent |
| Time to liquidity | Short term | Long term |
| Transfer restrictions | No restrictions | Existence of restrictions / right-of-first refusal |
| Size control of interest | Controlling interest | Non-controlling interest |
| Redemption rights | Existence of rights | No rights |
| Competence of management | Competent management | Incompetent management |
| Voting rights | Voting interest | Non-voting interest |
Although similar in concept to the above example, an undivided (i.e., fractional) interest in property is influenced by slightly different factors. Unlike an FLP interest, an undivided interest reflects a direct interest in the property itself. Although the property may be readily marketable, an undivided interest lacks the ability to sell the property, make decisions related to the property such as maintenance or leasing, or obtain normal bank financing without the other owners’ consent. Additionally, although no partnership agreement exists, per se, the owners may have signed a tenants-in-common (“TIC”) agreement, specifying restrictions on owners of the property.
Regardless of the existence of a TIC agreement, factors that can influence the valuation of an undivided interest include the following:
| Factors | Lower Discount / Higher Value | Higher Discount / Lower Value |
| Type of property | Developed / leased property | Vacant land |
| Cash flows | Income producing | Non-income producing |
| Number of owners | Fewer owners | More owners |
| Market forecast | Strong real estate market | Weak real estate market |
| Restrictions in TIC agreement removing right to legal partition | Retained right to partition | Removed right to partition |
| Other factors such as dissention among owners, foreclosure, etc. | Existence of negative factors | Lack of negative factors |
Conclusion
Although the Act made estate tax exemptions and rates “permanent”, future tax reform, including eliminating valuation discounts for interests in family-owned entities, are still possible. Under current legislation, however, opportunities exist for gifting assets/interests at discounted values. Understanding your gifting options and the value of your potential gift are critical components of the gift and estate planning process.
[1] Despite the Act, the Obama administration has proposed to amend the tax code to further restrict transfers by gift and other significant changes, outlined in our Tax Release dated April 22, 2013
[2] Frequently Asked Questions on Gift Taxes, Internal Revenue Service
[3] See IRS Publication 561 for a description of this asset and others.
