Parents gifting a home to their kid and their spouse, and them all hugging to celebrate.

What Is The Real Estate Gift Tax And How Can I Avoid It?

Jamie Johnson5-minute read

April 28, 2021

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Most parents want to give their kids advantages they never had growing up. And if you have the financial means, it may be appealing to give your child a home as a gift. But before you do this, you want to make sure you understand the real estate gift tax and how it will apply to your situation.

What Is The Gift Tax?

According to the IRS, the gift tax applies anytime an individual transfers property to another person without receiving full market value in return. Although it’s called the gift tax, the tax is applied whether the property is considered a gift or not.

This tax was instituted so that wealthy individuals can’t find loopholes to avoid paying estate taxes. The giver of the property is typically responsible for filing the gift tax return and paying any taxes due. But in special circumstances, the recipient may agree to pay the tax.

There is an annual exclusion per gift, per individual. The current exemption for gifts is $15,000 per individual or $30,000 per married couple.

How Are The Gift Tax And The Estate Tax-Related?

It’s easy to get the gift tax and the estate tax confused since both refer to the transfer of property. However, the gift tax on property refers to transfers made throughout an individual’s lifetime.

In comparison, the estate tax is applied when the property is transferred after death. As estate taxes fade in importance for most taxpayers, the strategy of gifting assets during one’s lifetime is becoming increasingly irrelevant for most.

The Policy Behind The Gift Tax

The gift tax and the estate tax are two separate policies, but they are somewhat related. The gift tax on real estate transfers was passed to prevent wealthy individuals from giving away their assets to friends and family during their lifetime. Under the current law, most taxpayers have no incentive to act solely for estate tax avoidance purposes.

Estate Taxes Affect Very Few Of Today’s Taxpayers

The 2017 Tax Cuts and Jobs Act doubled the estate exemption from $5 million to $11.58 million from 2018 – 2025. At this point, the exemption increase expires.

According to the Tax Policy Center, this generous expansion of the exemption reduced the number of taxable estates in the U.S. to 1,900 in 2019 and 2020, meaning that less than 0.01% of U.S. taxpayers will need to worry about estate taxes.

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How Does The Real Estate Gift Tax Work?

To give a bit more context for how the real estate gift tax on property transfers works, let’s take the example of fictional parents Ross and Rachel. They are currently in their mid-50s and plan on gifting a home to their adult child Emma and her husband.

Unless the gift amount exceeds the entire estate exemption (which is currently $23.4 million for a married couple in 2021), no taxes will be due on the gift. Let’s look at a few different scenarios and how the gift tax might apply.

If Ross And Rachel Have An Estate Worth More Than $25 Million And A House Worth $2 Million

By applying the annual gift tax exemption of $15,000 per spouse, per child, the first $60,000 of the gift is gift tax-free. Next, we’ll apply the estate tax exemption, and Ross and Rachel won’t pay any taxes on the transfer. However, they will use up part of their lifetime exemptions. 

If Ross And Rachel Have An Estate Worth $5 Million And A House Worth $300,000

In this scenario, we’ll apply the same $60,000 annual exemption. And once you use the estate tax exemption, there are no gift taxes to pay, but other tax problems could arise.

If The House Is The Bulk Of Ross And Rachel’s Estate

In this situation, the annual exemption will apply. Anything beyond that will come out of Rachel and Ross’s lifetime exemptions.

Longer-Term Consequences Of Gifting: The Capital Gains Tax

Another fact to consider is the cost of the gift Emma will receive – namely, the price her parents paid for the property. If Emma inherited the home after her parents’ deaths, she would have a cost basis of the fair market value of the home on the day of the surviving spouse’s death.

Although no taxes need to be paid until Emma sells the property, she will pay much more in the gift scenario, assuming what Ross and Rachel spent is far less than what Emma will someday sell it for.

What To Know Before You Gift

Before gifting property to another person, there are many things you should consider first. Several scenarios can cause unintended tax consequences and should be considered before the gift is made.

What Does Emma Plan To Do With The Property?

When you gift another person property, the recipient’s plans to sell or stay are crucial to determining a course of action. For instance, if Emma plans to sell the home quickly, she could get hit with a large capital gains tax bill.

That’s because Emma’s cost basis would be what her parents paid for the house, plus any capital improvements. Whereas if Emma plans to keep the home in the family indefinitely, she can pass it to her children at her death and avoid capital gains taxes altogether during her lifetime.

What Do Ross And Rachel Wish To Accomplish?

When parents decide to pass on property to their children, these decisions are rarely made on the basis of tax consequences. However, knowing what the ultimate goals are can help you decide on the most efficient path forward.

Shift The Tax Burden

Let’s say Rachel and Ross wish to provide their 20-year-old daughter – whose individual income is less than $40,000 in 2021 – with a home for a nest egg. In this situation, gifting the property may be a good route to consider in a seller’s market.

Emma can sell the house after holding it for over a year and avoid any capital gains taxes. However, Emma needs to sell the house before her income rises about $40,000 annually.

Stay In The Home

Another common scenario occurs when parents offer to give their child their home in exchange for living assistance. This is understandable, but there could be better alternatives for everyone involved. We’ll discuss some of those options in more depth below.

Qualify For Medicaid Coverage

Medicaid uses means-testing to determine who is eligible. So gifting a home may seem like a good way to receive Medicaid coverage for nursing home expenses.

However, there is a 5-year lookback period, and if the gift appears to have been made solely to avoid nursing home expenses, eligibility will be revoked. You should consult with an elder law attorney about protecting your assets before taking any action.

Alternatives To Gifting Real Estate

If you’re looking for ways to avoid the gift tax, here are some good alternatives to gifting real estate.

Sell At Fair Market Value

The IRS is on the lookout for any non-arm's-length transactions. So you might consider selling the home to your child at a fair market value instead.

Your child will own the home, and they can rent it back to you during your lifetime, deducting all household expenses as business expenses along the way. However, you will lose all control over the home in the process.

Place The Home In A Trust

Another option for parents is to place the home in a living trust for the benefit of their kids. After you die, the home will be available for your children to enjoy.

Create A Life Estate

Another option is to create a life estate, which is essentially pre-gifting your home to your kids while still retaining joint ownership. You retain full ownership of the property until you die, at which point it’s automatically transferred to the beneficiary. However, this can create complications if you want to sell or lease the home at some point in the future.

The Bottom Line: Decide Based On Your Needs, Execute According To Tax Law

Anytime you’re planning on transferring property to another person, you have to think about the real estate gift tax and how it will apply to your situation. Knowing how to avoid the gift tax on real estate can save you thousands of dollars down the road. To learn more about capital gains taxes and real estate, be sure to visit our Learning Center.

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Jamie Johnson

Jamie Johnson is a Kansas City-based freelance writer who writes about a variety of personal finance topics, including loans, building credit, and paying down debt. She currently writes for clients like the U.S. Chamber of Commerce, Business Insider, and Bankrate.