What it means
Instead of handing over a house outright, an owner might give a child a 20% share in it. Both then hold the property together as co-owners, and the giver retains the rest.
The same idea works for shares in a family company, a collection of artworks or a piece of land. The main reason for doing this is tax.
Many countries tax large gifts or tax the estate of a person who dies, and gifts below certain allowances may be free of tax. By giving away a series of fractions over several years, an owner may be able to use annual allowances repeatedly and move value to the next generation gradually.
A second reason is valuation. A minority share in a property or private company is harder to sell and gives its holder little control, so valuers often apply a discount to reflect this.
A 25% interest in a $2,000,000 property is therefore sometimes valued below $500,000, which reduces the taxable value of the gift. Charitable giving uses the same idea.
A collector may donate a fractional interest in an artwork to a museum, which then has a right to display it for part of each year, while the collector keeps the rest. Tax rules for such gifts are often strict, and may require the remaining interest to be given within a fixed period or may limit the deduction.
Tax authorities look closely at fractional gifts, and discounts can be challenged if the giver continues to use the asset as before or keeps control. The practical points are to document the gift, value it properly and act as a co-owner would.
Professional advice is essential because the rules differ by country and change over time.
In practice
Real-world examples.
Example
A founder owns 100% of a family manufacturing company worth $6,000,000. Each year she gives 10% to her son, and a valuer prepares a report on each gift. Over several years, a large part of the business passes to him with careful use of tax allowances.
Example
A collector owns a painting valued at $800,000 and donates a 20% interest to a museum. The museum displays the work for 20% of each year, and the collector keeps it for the rest. The collector claims a tax deduction based on the value of the fractional share, as permitted under the rules.
Example
A couple gives their two children a 15% interest each in a rental building worth $1,500,000. The children receive a proportion of the rent, and the parents continue to run the property. The lawyer advises them to put the arrangement in writing, so it can be shown to a tax authority.
Formula
Calculation
Value of gift = Total asset value x Fraction gifted x (1 - Discount rate)
Suppose a parent owns a property worth $2,000,000 and gives a 25% interest to a daughter. The pro rata value of the gift is 2,000,000 x 25% = $500,000.
If a valuer supports a 20% discount for lack of control and marketability, the value of the gift is 500,000 x (1 - 0.20) = $400,000. The reduction in the taxable gift is $100,000, which at an assumed gift tax rate of 40% would save 100,000 x 0.40 = $40,000.Case study
Seen in the real world.
Hartwell Family Holdings is a fictional company owned by a retired entrepreneur, Mr Okafor, who wanted to transfer value to his three children. The company's main asset was a commercial building valued at $3,000,000.
His adviser suggested gifting 10% of the building to each child every year for three years. Each gift was valued at 3,000,000 x 10% = $300,000 before any discount, and a valuer supported a 15% discount, which brought the value of each gift to $255,000.
In this illustrative case the discount reduced the total value of the gifts by 3 x 45,000 = $135,000. The family also agreed that the children would pay their share of the building's costs, which supported the case that the gifts were genuine transfers of ownership.
Watch out
Common mistakes.
- Giving a fraction of an asset but carrying on using it exactly as before, which can lead a tax authority to treat the gift as incomplete.
- Applying a valuation discount without a supporting independent valuation report.
- Forgetting that the recipient may inherit the giver's original cost basis, which can lead to a larger capital gains bill when the asset is sold.
Questions
People also ask.
Is a fractional gift the same as a gift of shares?
A gift of shares is one kind of fractional gift, but the idea applies to any asset that can be split, including property and art.
Why would a part-interest be worth less than its share of the whole?
A minority holder usually cannot force a sale or control decisions, and the interest is harder to sell, so buyers pay less.
Do the rules differ between countries?
Yes, taxes on gifts, allowances, valuation discounts and charitable rules vary widely, so always take advice from a qualified local professional.
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