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Wealth of Knowledge - A Trap for the Wealthy Do-Good Child

Mar 25, 2014

The question is often asked about a client who allows a parent or sibling to occupy real estate owned by the client on a rent-free basis: Is there any gift tax consequence?

In general, the answer appears to be yes under the United States Supreme Court’s decision in Dickman v. Commissioner, 465 U.S. 330 (1984). What was transferred here was the use of a substantial amount of cash for an indefinite period of time. An analogous interest in real property, the use under a tenancy at will, has long been recognized as a property right. For example, a parent who grants to a child the rent-free, indefinite use of commercial property having a reasonable rental value of $8,000 a month has clearly transferred a valuable property right. In such a case, there is a measurable economic value associated with the use of the property transferred.

In Dickman, the Supreme Court held that the foregone interest on an interest-free loan was a taxable gift. Despite the narrow set of facts in the case, the Court made several broad statements that suggest that the gift tax statutes apply to all situations in which one person allows another person to use property without compensation. Although Dickman involved interest-free loans, the Court’s view of the gift tax and the use of property quoted above is broad enough to support the notion that if a client allows a family member to live in a residence on a rent-free basis, the taxpayer will likely have made a gift of the foregone rent. The Court also pointed out that the annual exclusion and the unified credit should take care of most situations of this kind.

Further support comes from the Tax Court and the IRS who have taken the view that there can be a taxable gift in connection with a landowner’s failure to charge fair market rent. SeeWineman v. Commissioner, T.C. Memo. ¶ 2000-193 (2000) (here the taxpayer made a taxable gift by renting ranch property to her children at a below-market rate); and PLR 9433016 (requiring fair market rent in a post-QPRT termination lease arrangement). These authorities rely on the assumption that there is value in the use of property and that allowing someone to use property without paying for the use is a gift.

The Court in Dickman also pointed out that the annual exclusion should take care of most situations of this kind. However, wealthy do-good child is not going to allow mama to live in anything but the best.

Wealth of Knowledge - Spring 2014

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