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If you own real estate, your home is likely one of your most valuable assets. At some point, you might start to wonder if you can give property as a gift.
The answer is yes. If you own property, you can give it as a gift to a loved one, friend or even a charitable organization. There are different ways to transfer property, each with its own set of pros and cons. And gifted property may have certain tax implications for both the recipient and the gifter.
While you should always consult an attorney or tax professional when considering giving the gift of real estate, here are some options for gifting real estate and the tax consequences that might apply.
How Does Gifting Real Estate Work?
A gift of real property is when you give someone partial or complete ownership rights of a home in exchange for nothing or for less than its actual value. Gifting real estate is an extremely generous act. Unfortunately, the government doesn’t always reward that generosity with a tax break, so it’s important to understand the tax implications.
Gifted property can be taxable, but those taxes may vary based on different factors, like whether you want to make the gift during your lifetime or as an inheritance.
Most of the time, the recipient will only have to pay taxes on real estate when it’s sold for an amount that exceeds what’s known as the cost basis. Ordinarily, the cost basis is simply the original price paid for an asset.
There is, however, a key exception to the cost basis being the same as the original purchase price. To reduce the capital gains tax for recipients of assets, the Internal Revenue Service (IRS) allows for increases to the basis.
Instead of using the original price paid for an asset, the IRS has a “stepped-up” basis, which is the market value of an asset when the recipient receives the asset. The IRS uses different tax laws for gifting real estate depending on how the property is transferred to the new owner.
What Are the Potential Tax Implications of Gifting Real Estate?
The question many people find themselves asking is whether it is better to gift property or set up an inheritance. Generally, receiving property through inheritance is better than receiving property as an outright gift.
According to the IRS, gifts worth less than $17,000 (for the 2023 year) are exempt from gift taxes. Most real estate is worth more than $17,000, so there will likely be some tax implications when you gift a property.
If you give someone property worth more than $17,000, you’ll have to file IRS Form 709 to report the gift. Fortunately, the IRS lifetime exemption on estate and gift tax increased to $12.92 million per person in 2022. If your lifetime gifting remains below the $12.92 million threshold, you will be exempt from paying federal gift tax.
If you gift a property worth $360,000, you (and your estate, which consists of your collective assets, like cash, investments and other real estate) will still be able to avoid paying tax on $12.56 million worth of future gifts.
Capital gains tax
Recipients of real estate given as an outright gift may be responsible for capital gains tax on the original cost basis. If you purchased a home 25 years ago for $200,000, then gave it to your child as a gift for their wedding, their cost basis for taxes would be $200,000. In this scenario, capital gains taxes apply to the amount over the original purchase price.
Step-up cost basis savings
For gifted property that’s inherited, the IRS uses the stepped-up cost basis to determine the tax amount.
This means when the property is transferred to the heir (or heirs) named in the estate, its new basis will be “stepped-up” to the fair market value, which is the generally accepted price both buyers and sellers would agree to in ordinary circumstances.
Inherited real estate will trigger capital gains tax if the home is sold for an amount that exceeds the stepped-up cost basis.
How capital gains tax applies to real estate
Capital gains tax applies to real estate in two ways: short-term capital gains tax and long-term capital gains tax.
Short-term capital gains tax
Short-term capital gains tax applies when assets are bought and sold within one year of acquiring them. So if the recipient of gift real estate decides to sell the property within one year of receiving it, they would have to pay taxes on any short-term capital gains.
Short-term capital gains tax is treated as ordinary income and taxed at your individual applicable IRS tax bracket (money earned from working a salaried job).
For the 2022 tax year, short-term capital gains taxes range from 10% to 37%, depending on how you file, how much you earn and your marital status.
Long-term capital gains tax
Assets that are bought and held for more than one year before being sold are subject to long-term capital gains tax.
Long-term capital gains tax is preferred over short-term capital gains tax since it costs the recipient of gifted real estate less. Thus, many people will often hold assets for more than one year to avoid the increased expense of short-term capital gains tax.
Long-term capital gains tax can also change based on your income but can reduce your tax obligation compared with short-term capital gains tax. For the 2023 tax year, long-term capital gains tax can be as low as 0% for those who make $41,675 or less, while individuals making more than $459,750 will pay the highest capital gains tax rate of 20%.
If the gifted property is sold for a profit after more than two years during which the recipient used the home as their primary residence (for at least 2 out of the last 5 years), long-term capital gains tax would still apply, but only on the gains from the sale that exceed the IRS exemption for $250,000 per person / $500,000 per married couple.
What Are 4 Ways To Gift Real Estate?
There are four ways to gift real estate to a new owner, each with its own tax implications.
1. Gift real estate
As the gift giver, chances are you won’t have to pay any gift taxes when you sign the property over to its new owner. Although, the new owner might have to pay capital gains tax when they sell the home, which can add up quickly, as they’ll be taking on the cost basis from you.
2. Sell it at a personal loss
Selling real estate at a personal loss is another option for gifting real estate. If you own a home you bought for $600,000, you can sell it to a loved one for $500,000 and take a personal loss. You might want to sell real estate at a personal loss to reduce the gift size, or if the recipient wants to buy the home but can’t afford the full amount.
Selling your home at a personal loss can allow you to make a substantial gift without giving away the entire value of the home’s equity. This relieves you of the responsibility to care for the property.
When you sell a home at a personal loss, you won’t have to worry about paying capital gains tax. Keep in mind that if you lived in the home, or it was for your personal use, the IRS wouldn’t allow you to take a tax deduction on the loss.
However, if the home was used as an income-producing rental property, you may be able to take a capital loss, in addition to deducting up to $3,000 on other taxable income when selling the home at a loss.
Keep in mind you can’t take a deduction against ordinary income (like earnings from your job or investment dividends), so you’d have to realize a gain from selling assets such as stocks or bonds.
If the market value is $500,000 and you sell it for $100,000 to a family member, the IRS would deem that a gift of equity, for which you would have to file a gift return. As a gift, you also wouldn’t be able to claim a tax deduction on the losses from the sale.
3. Add them to the deed
Gifting a home to someone can be as simple as adding them to the deed, after which they share the rights to use the home and contribute to making decisions about the property.
Adding someone to a deed to gift real estate is achieved by creating a new deed and establishing a joint tenancy. A joint mortgage or joint tenancy is a type of home ownership commonly used by couples and family members.
Joint tenancy comes with rights of survivorship, so when a family member dies, their ownership share of the home is automatically divided equally between the surviving owners. With joint tenancy, each owner holds an equal share of the property.
One of the drawbacks of adding someone to a deed is that you don’t have complete control over your property anymore. Once a person is added to the deed, you can’t sell, refinance or rent it out without their permission.
Finally, adding someone to a deed without asking for anything in return is seen as a gift for tax purposes. If you own a house worth $500,000 and add someone to the deed, that would be the equivalent of gifting that person $250,000. As with other gifts, you would have to file Form 709 to report the gift, though paying gift taxes on this transaction likely won’t be necessary given the $12.92 million exemption.
4. Create a life estate
Creating a life estate is similar to adding someone to a deed. When you use a life estate to add someone to a deed, that person will have the rights of survivorship and become the sole owner when the other owners pass away.
By creating a life estate, you (and other owners if the property is jointly owned) become what’s known as a life tenant, retaining the rights to live in or profit from renting the property for the rest of your life. When the last life tenant passes away, the beneficiary – referred to as the remainderman – assumes full ownership of the property.
The benefit of a life estate to gift property is that the beneficiary inherits the property rather than receiving it as a gift. When the beneficiary receives the property, they enjoy the tax benefit of a stepped-up basis.
Before creating a life estate, you should be aware of the drawbacks. A life estate means you can continue using the property, but you also take full responsibility for maintaining the property and paying taxes. Furthermore, understand you can’t sell or refinance the property without the permission of the beneficiary.
When Can Gifting a House Be a Good Thing?
Giving the gift of a house is a great way to share real estate with someone you care about. Here are some common benefits:
Avoiding gift taxes
For most people, gifting a house is a great way to give a valuable gift without having to pay the gift tax associated with something like a cash gift.
Saving on capital gains taxes
You can also gift a house to someone to save on capital gains tax from the sale of the home. In this scenario, gifting a home to a family member can save thousands in taxes. When the recipient sells the home, the capital gains will be based on their (presumably lower) tax bracket rather than the gifter’s.
Getting a House Can Have More Strings Attached When It’s a Gift
Selling a house is a complicated affair; gifting a house can come with even more strings attached. However, if you plan to gift real estate, you can help make the process a little less cumbersome and a little less costly for the recipient by choosing the optimal way to transfer the property to its new owner.
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Internal Revenue Service. “What’s New – Estate and Gift Tax.” Retrieved January 2023 from https://www.irs.gov/businesses/small-businesses-self-employed/whats-new-estate-and-gift-tax
Internal Revenue Service. “Topic No. 409 Capital Gains and Losses.” Retrieved June 2022 from https://www.irs.gov/taxtopics/tc409
Internal Revenue Service. “IRS provides tax inflation adjustments for tax year 2023.” Retrieved January 2023 from https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2023
Internal Revenue Service. “Topic No. 701 Sale of Your Home.” Retrieved June 2022 from https://www.irs.gov/pub/irs-pdf/f709.pdf
U.S. Department of Health and Human Services Office of the Assistant Secretary for Planning and Evaluation. “Medicaid Treatment of the Home: Determining Eligibility and Repayment for Long-Term Care.” Retrieved June 2022 from https://aspe.hhs.gov/reports/medicaid-treatment-home-determining-eligibility-repayment-long-term-care-0
Internal Revenue Service. “Sales, Trades, Exchanges 1.” Retrieved June 2022 from https://www.irs.gov/faqs/sale-or-trade-of-business-depreciation-rentals/sales-trades-exchanges/sales-trades-exchanges-1