This week, Gail answers a reader's question and discusses the secret to avoiding gift and estate taxes: plan ahead.

Hi, Gail-

I graduated from college earlier this year and want to start building my credit history by buying my first piece of property. The problem is, without my parents’ help I won’t be able to buy anything.

They would like to gift me some money to help me out, but as I understand it, they are only allowed to gift $11,000 apiece or they will have to pay gift tax. Is this true? I read something about this being connected to the estate tax. Can you tell me anything about this?

Please help,
Jennifer

Hi, Jennifer

Congratulations on earning your diploma! In my opinion, “real life” experiences, such as making your first real estate purchase, can be every bit as challenging as college and teach valuable lessons you will carry with you the rest of your life. That’s why I want this to be a positive experience.

Before you dive into the real estate market, I strongly recommend you have most, if not all, of your student loans paid off. In addition, I would like to see you set aside at least 3 months’ worth of living expenses. (Six months’ worth would be even better.) Include your personal expenses- clothing, food, entertainment, transportation, etc. — as well as what you estimate your total costs will be for a piece of property in your price range.

As a young, single college graduate, you don’t want to saddle yourself with so much debt you have no money left to enjoy your new independence. A mortgage, property taxes, insurance, etc., can quickly become overwhelming, especially if your first job isn’t secure. What if your boss turns out to be Attila the Hun? If you’ve got fixed expenses, you may be compelled to stick with a lousy job just to pay your bills.

OK. Enough of Gail’s lecture! On to your questions:

Your information about the annual gifting limit is outdated. This year, the maximum amount an individual can give someone who is not their spouse is $12,000. While this amount is periodically adjusted for inflation, it is not scheduled to increase next year.

In the eyes of the law, when you “gift” assets (money, real estate, securities, a car, etc.) to another person, you are transferring ownership while you are alive; transferring ownership after you die is called “bequeathing.” At that point, your assets are also known as your “estate.”

The federal government and most states impose a tax when you transfer ownership of property that exceeds certain limits. The federal limit on “gifts” is currently $12,000/year; to avoid estate tax, the maximum you can transfer at death is $2,000,000 through 2008.*

So, the first thing to understand is that both “gift” and “estate” taxes are “transfer” taxes, i.e. they come into play when you change the legal ownership to someone else. The type of tax you pay depends upon whether you are alive or dead when the transfer occurs.

Notice that it is the person who is doing the transfer that is taxed — not the recipient of the property.

The connection between “gift” and “estate” taxes is that gifts that exceed the annual limit are added up at your death and can reduce the amount of assets you can bequeath estate tax-free. However, without going into the complicated math, suffice it to say that unless your parents are wealthy this is not going to be an issue.

The second point is this: Very few people pay either gift or estate tax. Under current law, an individual would have to make more than $1,000,000 worth of “excess” gifts (amounts over the annual limit) before triggering gift tax. According to the IRS, only about 2 percent of estates end up paying estate tax.

Here are a couple of ways your parents could contribute significantly more money toward a downpayment on your first home:

-If they don’t want to exceed the annual gifting limit they can give (“gift”) you a total of $24,000 ($12,000 each) before the end of 2006 and another $24,000 in January. Thus, by next month, you’d have $48,000 to put toward the purchase price. Or,
-Purchase the property with your parents, i.e. they would be part-owners. Each year they can “gift” a combined total of $24,000 of the property’s value to you.

The latter is more complicated as your parents would not only share ownership of the property, they would also share in the liability — something they might not want. And they would need to involve a lawyer each time they gifted a portion of the property to you.

As you are undoubtedly aware, real estate prices around the country have declined considerably, so this is a good time to shop around. Take your time. You’re very fortunate to have such generous parents.

All the best as you take this important step into adulthood!

~Gail

*There is no limit on the amount of assets you can give or bequeath your spouse.

If you have a question for Gail Buckner and the Your $ Matters column, send them to: yourmoneymatters@gmail.com, along with your name and phone number.