What Is The Three-Year Rule in California?

The Three-year rule is part of the IRS tax code that deals with assets, transfers, and estates. The rule places certain assets in the total for the decedents’ gross estate when those assets are transferred within three years of the person’s death.

When someone transfers property or assets to another person within three years of their death and they do so at less than fair market value then those properties or assets will be considered as part of the gross estate and an estate tax is levied against them.

What About Property Sold or Transferred at Fair Market Value?

The key here is “fair market value.” Property that is sold within three years of the person’s death is not returned in value to the gross estate and is not taxed again since the taxation for that property already occurred at the sale and because the price was at a fair market value. That is a little tricky, but the Three-year rule is set in place to stop pre-death transfers of property and assets to avoid the fair tax on them.

Gifts are also included in this and are not normally part of the three-year rule. Certain gifts of life insurance proceeds are taxable and some are not. The key here is whether the person who has passed retained any incident of ownership – Interest that is equal to or greater than five percent of the life insurance policy.

Why Does The Three-Year Rule Exist?

Historically, people who were dying have transferred property and assets to their beneficiaries before their death occurred as a means of reducing their estate tax. Upon death, the deceased estate is valued and then taxed. Because people were trying to skirt the IRS laws and attempting to escape taxation on assets, congress enacted the Three Year Rule.

There are exceptions and limits placed within the tax code that make it possible for the three-year rule to apply to one estate and not the next. Much of that depends on the value of the estate and the nature of the assets. 

For example, certain assets include:

  • Revocable Trust Transfers
  • Retained Life Insurance transfers
  • Transfers of life insurance proceeds

The assets above are often the target of the three-year rule. Exceptions occur when the asset is sold at fair market value and not at a reduced cost. For example, if someone sells a piece of property three years before they die at full fair market value, the asset is transferred and will not be included in the gross estate value – regardless of who they sold the property to. If the person sells the property at a discount from what the fair market value of the property is, the gross estate value is increased to include the difference between the discounted sale price and the fair market value of the property.

Call The Law Offices Of Charles D. Stark For More Estate Planning Information

For comprehensive estate planning turn to the Law Offices of Charles D. Stark based in Sonoma County.  We are available to help you understand your options for handling your entire estate.

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