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Gift Tax on Spouse Property Transfers and IRS Gift Limit

Gift Tax on Spouse Property Transfers and IRS Gift Limit

Section 1041 of the IRS Code outlines the tax rules surrounding property transfers between married and divorcing couples, but there are some holes in the code when it comes to international rules of taxation. For example, Section 1041(b) of the IRS Code states that any transfers made to nonresident spouse are subject to taxation as income rather than a gift. Generally speaking, property transfers within a marriage or as the result of a divorce are not treated as income gain or loss; they are treated as taxed as gifts, and any taxes due are considerably less than they would have had the ‘gift’ been viewed as taxable income.

Tax Rules and Regulations on Gifts

Section 2051(a)(1) defines the rules and regulations of taxation on property transfers as gifts, and it indicates that taxes will be imposed on inter-spousal transfers. There are various exceptions to this rule, though, in which the tax may be reduced or eliminated based on specific marital or divorce situations. One of these exceptions includes the “Unlimited Gift Tax Marital Deduction,” which allows the value of marital gifts or transfers to be deducted from the total amount of gifts for the tax year. When this deduction is elected, it eliminates the assessment of gift tax on transfers that were made within a marriage. 

The aforementioned rule may also apply to divorce situations. If a written agreement had been settled upon as part of a divorce settlement, all transfers made pursuant to such agreement within a specific timeframe are considered to be non-taxable. When these items of IRS Code Section 2051 are considered along with Section 1041, the absolute result is that any and all transfers made between a husband and wife will always be free of taxation.

The Difference between Income and Gift

It’s important to understand that certain property transfers may be technically viewed as income if there is an exchange of goods. A gift is recognized as something which was given for nothing; in an exchange of goods, both parties receive something. Divorce settlements, for example, which stipulate what each spouse will get are considered exchanges rather than gifts, because both parties are receiving something from the exchange.

Gift Tax Rules for Non-Citizen Recipients

If the recipient spouse is not a US Citizen, the Unlimited Gift Tax Marital Deduction mentioned above will not apply. There is, however, a large deduction still available for marital transfers or gifts. The limit of the marital exclusion for non-citizen spouses is $139K for 2012. Because of this limitation, inter-spousal transfers from one US Citizen Spouse to a non-citizen spouse are thoroughly scrutinized for potential gift tax liability. As such, it’s important to ensure that the most reliable appraisals are acquired.

Non-Resident Income tax vs. US Citizen Gift Tax

The consideration of an income tax loss or gain on transfers within a marriage or as part of a divorce settlement is contingent upon the spouse’s status as a resident or nonresident alien. If the recipient spouse is a resident alien, no tax loss or gain will be factored; if the recipient spouse is a non-resident alien, taxes will be assessed by considering the amount of loss or gain. If the recipient spouse is a citizen of the United States, the transfer will not be subject to taxation. This rule applies even if the spouse is currently living in another country. 

The consideration of gift tax loss or gain is different than income tax for resident aliens. As indicated in the last paragraph, resident aliens will not be responsible for income tax on the transfer; there are situations, however, in which a resident alien will be liable for gift taxes on a property transfer from a spouse – whether it is a spousal or divorce transfer.

Example of Gift Taxes with Non-Citizen Spouses

Let’s say there is a husband who is a US Citizen and a wife who is a Green Card Holder and that this couple lives in the United States. The husband gives the wife 50% ownership of a piece of real estate he owns that is valued at $600K, so the value of the gift is $300K. Only $139K of this amount can be claimed as a marital deduction, so the remaining $161K is considered a taxable gift.

If The Recipient is a US Taxpayer…

If the value of a gift that a US taxpayer received from a non-resident exceeds $100K, the gift must be reported to the IRS on Form 3520. For example, consider a situation in which the husband is a nonresident alien and the wife is a US Citizen. If the husband gives the wife a gift for $250K it must be reported on Form 3520.  

If you are confused about the tax implications on a gift to or from your spouse, don’t hesitate to contact a US expat tax professional at Taxes for Expats.

Ines Zemelman, EA
Founder of TFX