It’s not uncommon for family members to make a gift to a married couple. Usually, when a generous family member contemplates the couple, they assume that the marriage will continue. It also allows for a doubling of the annual gift tax exclusion amount (the well-known $15,000 figure). But sometimes the gift was really intended to benefit one spouse rather than both. What are the rules about such gifts?
Arizona is a community property state
Let’s start with one of the most confusing issues: what are the rules for community property states, like Arizona? The answer is actually simple. Application of the answer almost always requires further explanation.
Like other community property states, Arizona starts with a presumption. Property acquired during the marriage (regardless of how it was acquired) is presumed to be community property. But if the property was a gift or inheritance, that overcomes the presumption. Gifts and inheritances are separate property — or at least they are when received by one spouse.
So each spouse owns what they brought into the marriage, plus anything they received by gift or inheritance. But there’s more: it’s really easy to convert that separate property into community property. And it’s really hard to turn community property (back) into separate property.
So imagine that your generous great-aunt Gayle wants to give you (and your spouse) $100,000. Or a house. Or a car. If you take the gift and title it as community property — it’s community property. If you want to keep it separate, it’s important that you do not put your spouse’s name on the gift. Was the gift made to both of you? Then if you want to keep your half of the gift separate, it’s important that you keep your share of the gift in your name alone.
A recent case from South Dakota
We were thinking of these principles as we looked at a case from the South Dakota Supreme Court this week. It involved a gift to a married couple — an existing farm — so they could take over the farming. Actually, it didn’t really involve a gift — it involved a sale for much less than the value of the property. This is going to take some explaining.
First, though, South Dakota is not one of the nine states that apply community property rules to most transactions involving married couples. But that turns out not to be important to understanding the principles, or applying the South Dakota case to gifts in Arizona.
Back in 2006, Dennis Ryland offered to sell his South Dakota farm to a relative, Matt Field — and his wife Aren. Dennis wanted to keep his farm in the family. He had one child, who had left South Dakota and didn’t want to be a farmer. Dennis’ great-grandfather had homesteaded the land in 1878, and Dennis wanted to keep the land in his family. So he gave Matt and Aren an option to purchase the farm for $300,000.
The farm was probably worth about $1.8 million at the time, so the offer was pretty generous. The Fields exercised their option in 2010, and signed a $300,000 note that called for $15,000/year payments and 5% interest. Still an exceptionally good deal. They took title to the farm in both of their names.
Aren worked outside the home until 2014, when she quit her job and stayed at home raising the couple’s children and helping manage the farm. Matt also held outside jobs, even as he was farming. They were able to keep the farm going partly because of Matt’s relative’s sweetheart deal.
Trouble on the farm
In 2016, Aren took the children and moved out of the farmhouse. She filed for divorce, and the couple quickly agreed that their marriage was broken. But how to divide the farm?
For his part, Matt argued that a gift to a married couple isn’t always a gift to both of them. He allowed as how Aren’s part of the farm should include the $300,000 purchase price and payments made on the note — but the rest of the value had been a gift to him, not to them.
Matt’s relative Dennis testified that he had intended the gift to be to a family member, and to keep the farm in the family. He knew he had effectively made a large gift to the married couple, but he had mostly intended that it benefit Matt, his relative.
The divorce judge agreed with Matt’s interpretation, and awarded Aren half of the purchase price of the farm. Aren appealed, arguing that any gift made by Dennis was a gift to both of them.
The South Dakota Supreme Court explains the law
In the trial court and on appeal, Aren argued that the gift had been to the couple, not primarily to Matt. That was evidenced by the fact that they signed the contract as a couple, and they both took on responsibility for the loan. Besides, she pointed out, she had actually worked on the farm alongside Matt, and it was clearly marital property.
The state’s high court agreed with Aren. A gift to a married couple, ruled the justices, is just that: a gift to both of them. The nature of such a gift should be judged at the time of the transfer, not by later reengineering. Even though Dennis now maintains that he primarily intended to benefit Matt, at the time the transaction was with both of them. Plus they took title in their joint names.
That means that the property is now owned by the two of them equally. And even if that were not true, the fact that Aren worked on the land with her husband, and made payments on the note along with him, would have made at least some of the farm joint property anyway. But the court wanted to be clear: there’s no need to get to the fact that Aren contributed to management of the farm, since her name is on the title. Field v. Field, September 9, 2020.
Does this apply in a community property state?
The Field case, though coming from a different state (and a non-community property state, at that) would probably be persuasive in Arizona. Note that the South Dakota Supreme Court decision doesn’t actually rely on the common law concept of marital property (their analogue for our community property rules). It focuses on how the transfer was made, and what the documents say.
So if Dennis, Matt and Aren had all lived and farmed in Arizona, the result would likely have been the same. Except, of course, that Matt and Aren would probably have taken title to the farm as “community property with right of survivorship.” But that’s a story for another day.
Did you notice that Dennis made a $1.5 million gift to the married couple? Doesn’t that vastly exceed the $30,000 he can give to Matt and Aren?
Yes, but people often misunderstand the gift tax law. It doesn’t prohibit large gifts. And there is no federal gift tax on most gifts. They just require filing of a federal gift tax return, and a reduction of the giver’s lifetime estate/gift tax exemption amount. In 2010, when they signed the sale agreement, Dennis’s lifetime exemption was $5 million. Presumably he filed a federal gift tax return, but he wouldn’t have had to pay any tax.
Actually, the answer is slightly more complicated by the fact that there were two different choices for just the year 2010, but that’s more confusing than helpful. So we’re going to ignore it. We’re also going to ignore the possibility of a South Dakota state gift tax — though we have no reason to doubt this online assertion that South Dakota, like Arizona, has no gift tax.