Gifting Property: Your Options Explained
Jamie Johnson6-minute read
October 21, 2023
If you own real estate, then at some point, you may have considered gifting it to a friend or family member. Some people gift real estate after they pass away, while others give it to their adult children to help them get a good start in life.
After all, if you have the financial means, it may be appealing to give your child a home as a gift. But before you do, there are some tax consequences you’ll want to consider. If you’re strategic about it, there are ways to gift real estate and minimize the potential tax burden at the same time.
Gifting A House: An Example
To illustrate this idea, let’s look at two fictional parents who are considering gifting a piece of real estate to their child as a wedding gift. The couple paid $350,000 for the property, and they are wondering what IRS regulations they should know about before they gift the home to their child.
Basis Of Gifted Property
Anytime you gift another person property valued over $15,000, you have to fill out a gift tax form. But everyone receives a lifetime higher estate and gift tax exemption of $12.92 million per individual as of 2023.
That means as a married couple, our fictional parents can gift up to $25.84 million without paying any federal estate or gift tax. Thanks to this exemption, the majority of U.S. taxpayers can gift real estate without having to deal with the real estate gift tax.
However, by gifting the property, these parents could cause their child to end up with unintended capital gains taxes down the road. If their child ever plans to sell the home, they could end up paying hefty capital gains taxes.
So, the first step these parents need to take is to determine the basis of the gifted property. According to the IRS, there are three things you need to know to determine the tax basis of a property:
- The adjusted basis before the property was gifted
- The fair market value of the property
- Any amount of gift tax that’s already been paid
In this situation, the parents’ tax basis of $350,000 becomes their child’s tax basis once they receive the property. They won’t have to pay the gift tax because it’s so much lower than their lifetime exemption.
And if their child immediately sells the property for $350,000, they won’t owe any capital gains taxes. But down the road, if the child sells the property for $450,000, they’ll owe a capital gains tax on $100,000.
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Ways To Gift Real Estate
Given the potential tax consequences, what is the best way to gift property to another person? Let’s look at four different scenarios you can consider.
Gift Real Estate
In this situation, the parents could proceed as planned and gift the property to their child at the child’s wedding. They’ll transfer the title to their child, who will receive the home as an outright gift. This is the most straightforward option, but there are some downsides to using this strategy.
Since the property’s tax basis is $350,000, it exceeds $17,000 and the gifting parents would need to fill out a gift tax form. But $350,000 is far below their lifetime exemption of $25.84 million, so they won’t owe any gift tax.
And if their child keeps the property, the child won’t be responsible for any capital gains taxes. But if they eventually sell the home at a profit, they’ll be responsible for paying capital gains taxes on the difference.
Sell To Your Loved One At A Personal Loss
Another option gifting parents can consider is giving a gift of equity. They’ll sell the home to their child at a price well below the appraised market value.
Giving a gift of equity is a way for owners to gift real estate to their children or other relatives even if these buyers don’t have enough cash to cover a down payment or the larger monthly payment that would come from a home sold at market value.
For instance, the fictional parents in our example could sell the home to their child for $100,000. Since the house is worth $350,000, they’re giving a gift of equity of $250,000.
There are no immediate tax consequences to giving a gift of equity. But in this situation, the child will likely have to pay long-term capital gains tax on the gift of equity, and the parents may be able to deduct their loss from their taxable income.
Add Your Loved One To The Deed
Another option that parents can consider is adding their child to the deed. Basically, they’re giving their child joint tenancy with the right of survivorship. All three individuals in this situation own the property together and have equal rights.
If one of the tenants dies, then the rights automatically transfer to the surviving tenants. So, assuming the child outlives their parents, they’ll retain full ownership of the property.
One of the problems of joint ownership is that it can limit your ability to make decisions about the property. For instance, if the child wanted to sell the home down the road, they would have to receive permission from both parents.
If you aren’t careful, joint tenancy can cause relationship strains between you and your loved ones. The Internal Revenue Service (IRS) still considers joint tenancy as a taxable gift, so if you do end up selling the home, they’ll have to pay capital gains tax.
Create A Life Estate
Another option is to set up a life estate, which is another way of creating joint ownership of the property. The parents would establish a life estate and make their child the sole beneficiary.
In this scenario, the parents can continue living in the home if they choose, and the title is automatically transferred to their child if they die.
In this case, the property is considered an inheritance rather than a gift. So if the child decides to sell the property, they can do so at an adjusted basis for the current market value of the property.
The advantage of this is that for the time being, the parents can pass on the property to their child and get to avoid the gift tax. But the parents, their child and the child’s spouse will have to readjust their roles in relation to the property.
For instance, they’ll have to determine who is responsible for paying for things like property taxes. They’ll also have to decide who gets to live in the home in the meantime.
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How To Gift Real Estate
If you’re considering gifting real estate to a loved one, here’s what you can expect the process to look like:
1. Explore Your Options
First and foremost, you’ll want to ensure you fully understand your options for gifting real estate and the tax implications each has for both the giver and recipient. You don’t want any unexpected surprises down the road, so be sure to take the time to learn about each option and which may be best for you.
2. Consider Consulting A Real Estate Attorney
As you’re considering your options for gifting real estate, you may want to consult with a real estate attorney. These professionals are likely the best people to explain how each option works and which might make the most for your situation. Having an attorney on your side can help you more confidently make a decision about the best way to transfer your property to your loved one.
Receiving A House As A Gift
Let’s return to our example from before, where our fictional parents eventually decide to give the home to their child as an outright gift. Since the tax basis for the home is $350,000, they won’t owe any gift taxes outright.
Also, their child can avoid paying any capital gains taxes by keeping the property. If they do choose to eventually sell the home, they’ll pay capital gains taxes on any amount they receive over $350,000.
The Bottom Line: This Gift Requires A Professional Consult
When you’re gifting property to another person, there are a number of different things you need to consider. The first is the gift tax, and whether your gift will exceed the lifetime exemption.
You’ll also want to consider the capital gains tax, which could come into play as an equity gift or a capital gains tax if your child sells the home too soon. If you’re considering gifting property to a child or family member, be sure to consult with a lawyer or tax professional first.
Before you begin the process of gifting a house to your child, explore how parents can help their children own a home.
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How To Buy A House From A Family Member In A Non-Arm’s Length Transaction
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Kevin Graham - October 26, 2023
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