Gifting Property: Your Options Explained

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.

To illustrate this idea, let’s look at the fictional characters Johnny and Moira, who are considering gifting a piece of real estate to their son, David, as a wedding gift. The couple paid $350,000 for the property, and Johnny and Moira are wondering what IRS regulations they should know about. 

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 $11.7 million per individual, which is up from $11.58 million in 2020.

That means as a married couple, Johnny and Moira can gift up to $23.4 million without paying any federal estate or gift tax. According to the Tax Policy Center, less than 0.01% of U.S. taxpayers will have to deal with the estate tax.

However, by gifting the property, David could end up with unintended capital gains taxes down the road. If he ever plans to sell the home, he could end up paying hefty capital gains taxes.

So, the first step Johnny and Moira 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 cost 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, Johnny and Moira’s tax basis of $350,000 becomes David’s tax basis once he receives the property. They won’t have to pay the gift tax because it’s so much lower than their lifetime exemption.

And if David immediately sells the property for $350,000, he won’t owe any capital gains taxes. But down the road, if he sells the property for $450,000, he’ll owe a capital gains tax on $100,000.

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.

In this situation, Johnny and Moira could proceed as planned and gift the property to David at his wedding. They’ll transfer the title to him, and he’ll receive the home as an outright gift. This is the most straightforward option, but there are some downsides to using this strategy.

Tax Considerations

Since the property’s tax basis is $350,000, it exceeds $15,000 and Johnny and Moira would need to fill out a gift tax form. But $350,000 is far below their lifetime exemption of $23.4 million, so they won’t owe any gift tax.

And if David keeps the property, he won’t be responsible for any capital gains taxes. But if he eventually sells the home at a profit, he’ll be responsible for paying capital gains taxes on the difference.

Another option Johnny and Moira can consider is giving a gift of equity. They’ll sell the home to David 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, Johnny and Moira could sell the home to David for $100,000. Since the house is worth $350,000, they’re giving a gift of equity of $250,000.

Tax Considerations

There are no immediate tax consequences to giving a gift of equity. But in this situation, David will likely have to pay long-term capital gains tax on the gift of equity. And Johnny and Moira may be able to deduct their loss from their taxable income.

Another option Johnny and Moira can consider is adding David to the deed. Basically, they’re giving him joint tenancy with the right of survivorship. Johnny, Moira and David all 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 David outlives his parents, he’ll retain full ownership of the property.

Tax Considerations

One of the problems of joint ownership is that it can limit your ability to make decisions about the property. For instance, if David wanted to sell the home down the road, he would have to receive permission from both Johnny and Moira.

If you aren’t careful, joint tenancy can cause relationship strains between you and your loved ones. And the IRS still considers joint tenancy as a taxable gift. So, if you do end up selling the home, they’ll have to pay a capital gains tax.

Another option is to set up a life estate, which is another way of creating joint ownership of the property. Johnny and Moira would establish a life estate and make David the sole beneficiary.

Johnny and Moira can choose to continue living in the home if they choose, and the title is automatically transferred to David if they die.

And the property is considered an inheritance rather than a gift. So, if David decides to sell the property, he can do so at an adjusted basis for the current market value of the property.

Tax Considerations

The advantage of this is that for the time being, Johnny and Moira can pass on the property to David and get to avoid the gift tax. But Johnny, Moira, David and his husband Patrick 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. And they’ll have to decide who gets to live in the home in the meantime.

Johnny and Moira eventually decide to give the home to David as an outright gift. Since the tax basis for the home is $350,000, they won’t owe any gift taxes outright.

And David can avoid paying any capital gains taxes by keeping the property. If he does choose to eventually sell the home, he’ll pay capital gains taxes on any amount he receives over $350,000.

If you’re considering giving a gift of equity to a family member, here are a few things you should consider first.

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.

And be sure to check out this guide on how parents can help their children own a home.