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Friday, October 27, 2006


Taxpayers often gift away partial interests in family real property to other members - often as gifts of tenancy in common interests. These taxpayers do not expect that the interests that are gifted away will be subject to estate tax at the donor's death. However, a recent Tax Court case demonstrates that if the donor retains economic interests in the gifted interests, or continues to use the entire property, Section 2036 can result in estate tax inclusion of the entire property.

In Estate of Margot Stewart v. Commissioner, T.C. Memo 2006-225, a mother gifted away a 49% tenants in common interest in real property to her son. The transfer qualified as a completed gift for gift tax purposes. During the mother's remaining lifetime, she continued to live in the property, she received all of the rental income that the property generated, and paid most of the expenses of the property. Due to these facts, the IRS sought to include 100% of the value of the property in the mother's estate when she died. The taxpayers objected, but the Tax Court sided with the IRS and allowed the 100% inclusion.

The case is a demonstration of what NOT to do. Reverse the facts and you come up with some guidelines towards avoiding Section 2036 inclusion when a partial interest in property is gifted away, including:

-The donor should not continue to use the entire property, unless paying fair rent for the portion the donor no longer owns.

-Divide any rental income pro rata in accordance with the percentage ownership interests.

-Divide the expenses pro rata in accordance with the percentage ownership interests.

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