New Section 2704 Regulations

As those of you who follow the inside baseball of estate planning surely know, the Treasury Department recently promulgated regulations under Internal Revenue Code Section 2704. The detailed discussion of these regulations is obviously beyond the scope of a blog post, but it is worth noting their effect in broad brushstrokes.

Section 2704 relates to discounts that may be applied to gifts. What “discounts”? For instance, if you give a gift within a family, you may apply a “discount” to it - either because it’s not marketable or because it’s a minority interest - thereby lowering the amount of the gift for purposes of computing the gift tax.

 

Here’s a simple example:

Imagine that your generous uncle gives your sister $100,000 and gives you one-third of a $300,000 ski condo; and imagine that you don’t ski, you live in Miami, and the ski condo is in Utah.

You don’t really feel like you got an equal gift, do you? That’s because you are mentally applying a discount to the one-third interest in the $300,000 condo. You’d really rather have the $100,000 cash, even though technically they have the same value. To the IRS, the fact that the condo isn’t far away isn’t relevant, nor is the fact that you don’t ski! However, relevant factors that would support discounting the value of the gift are (i) the fact that a one-third interest is a heck of a lot harder to sell than a whole ski condo (a “marketability discount”) and (ii) the fact that as one-third owner, you have no control over when to make major repairs, whom to rent it out to, when to sell it, when to take a mortgage, even when you can use it (a “minority discount”), because you own a minority of the interest in the condo. So, with an appropriate third-party appraisal, your uncle might file a gift tax return showing a $100,000 gift to your sister and a gift of a one-third interest valued at $75,000 to you.

As our example illustrates, with a little planning, once can save substantial gift taxes and estate taxes using discounting principles. Sounds good, doesn’t it? (Consult your estate planner for opportunities in this area, especially if you own $300,000 ski condos.)

Back to our topic: The new regulations under Section 2704 substantially limit the abilities of families to obtain valuation discounts for gifts between family members. This is something that might affect you either as a person who considering making such a gift, or as a beneficiary of someone who has made such a gift in your family, either in trust or to you directly. Be sure to consult your estate planner.