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What Is the Real Estate Gift Tax and How Can I Avoid It?

TLDR

What You Need To Know

  • The IRS imposes a gift tax on homeowners anytime a property is transferred to someone else in exchange for nothing or less than the full value of the house
  • Gifted property is taxable by law, but for the 2022 tax year, the IRS has a lifetime gift and estate tax exemption of $12.06 million per person
  • The gift tax rate starts at 18% and tops out at 40%

Contents

Giving someone the gift of real estate can be a great way to show your love and keep a house in the family. But gifting property can have certain tax implications, like the federal gift tax.

If your parents, grandparents or anyone else wants to give you a house as a gift, they’re entitled to do so, as long as they file a gift tax return form and pay any applicable taxes. Gift taxes on real estate can be complicated and expensive, but we’re here to help teach you what you need to know about the gift tax on property and how you may be able to avoid it.

What Is the Real Estate Gift Tax?

The Internal Revenue Service (IRS) imposes a gift tax on homeowners anytime a property is transferred to someone else in exchange for nothing or less than the full value of the house. All U.S. citizens and residents who give gifts exceeding $16,000 for the year must file the gift tax form, also known as Form 709.[1] [2]

The IRS gift tax isn’t designed to prevent people from giving gifts to others. Rather, it exists to help the government prevent people from skipping out on paying taxes when transferring wealth. For example, if you gift property to someone during your lifetime, you’ll be responsible for paying gift tax.

Gifted property is taxable by law, but for the 2022 tax year, the IRS has a lifetime gift and estate tax exemption of $12.06 million per person.[3] That means you can give up to $12.06 million worth of gifts to others without having to pay tax. 

Just remember that this amount includes not only what you give when you’re alive, but also what you leave behind after death. However, the IRS isn’t looking to tax every dollar you give to someone else, so only large gifts (those over $16,000 for 2022) count toward the $12.06 million exemption limit.

Gift tax vs. Estate tax

Federal gift taxes and federal estate taxes are often confused, mainly because they share the same federal tax rate and lifetime exclusion. The key difference is that gift tax applies during your lifetime, while estate tax takes effect after death.

How Does the Gift Tax Work?

When gifting a property, there may be certain tax implications for the giver of the house (aka the grantor). We already covered why the gift tax exists. Now, let’s examine how the federal government’s gift tax works, including who pays it and how much it can cost.

When does gift tax apply?

The federal gift tax applies to any gifted real estate exceeding $16,000 for 2022 (or $32,000 for married couples).[1] Keep in mind that the IRS might change this number in the future. 

Gift taxes can also apply regardless of intention. Even something that doesn’t necessarily look like a gift, like if your parents offered to sell you their house at market value and give you an interest-free loan, can be subject to the gift tax.

Who pays gift tax? 

For real estate, the gift tax is paid for by the person who owns the house and is transferring part or all of the property to someone else. If the amount of the gift falls within the IRS’s lifetime estate and gift exclusion, the grantor still has to fill out Form 709 and send it to the IRS – even if they don’t end up owing any tax money as a result.

How much is the gift tax?

The gift tax rate starts at 18% and tops out at 40%. Gift taxes are progressive, meaning the more money you give, the higher the tax rate will be.[4] 

An example of the gift tax

You and your spouse just had a baby – congratulations! Your parents are planning to move into a condo so they don’t have to worry about stairs and snow. And since you’ve been house hunting in their neighborhood anyway, they’d like to sell you their home at a steep discount.

Though your parents’ house is worth $900,000, they’re willing to sell it to you for just $350,000. So in the eyes of the law, your parents are giving you a gift of equity totaling $550,000. Even though you’re purchasing the house from your parents, it’s still considered a taxable gift, which requires your parents to complete and submit Form 709.

How Can You Avoid Gift Tax?

In many cases, you can avoid paying gift tax by taking advantage of the IRS’ annual and lifetime exclusions.

Gift tax annual exclusion

The annual gift tax exclusion allows gift-givers to avoid paying taxes or filing Form 709 with the IRS, provided the gift is less than the annual limit. For 2022, the IRS annual gift tax exclusion is $16,000 for individuals or $32,000 for married couples filing jointly.[1]

Gift tax lifetime exclusion

If you give someone a gift exceeding $16,000, whether it’s real estate, stocks or bonds, you’ll have to file Form 709. But in many cases, you won’t have to pay any taxes. Like the annual exclusion amount, the IRS also has a lifetime exemption amount for gifts you make before and after you die via your estate. For 2022, the lifetime gift tax exclusion is $12,060,000.[3]

Are There Alternatives to Gifting Property?

If you want to transfer property to someone else, there are a couple of alternatives to just giving it as a gift. However, in some cases, you’ll still be responsible for gift or estate taxes.

Selling the home at fair market value 

The IRS often scrutinizes non-arm’s length transactions, which are dealings that occur between people who have a personal or professional relationship. One of the simplest alternatives to gifting property is simply selling the home at its fair market value and then gifting the proceeds.

Creating a living trust 

A living trust transfers the deed to a property into a legal entity (sort of like a corporation) where it’s held and managed by a trustee (a person – often the individual who created the living trust – or institution that has a legal responsibility to carry out the terms of the trust).

If you create a living trust, you retain full control over the property for as long as you live. Then, upon your death, the living trust automatically transfers ownership of the property to the beneficiary named in the trust. 

The tax implications would be the same for you as if you gifted the property during your lifetime. But in this scenario, the gift recipient would save on capital gains taxes when they sold the house thanks to the stepped-up cost basis. (We’ll get more into this later.)

Implementing a quitclaim deed

A quitclaim deed is a popular way to transfer property quickly, but it’s usually reserved for use between family members, loved ones or when the grantor and grantee know and trust each other. 

Depending on the relationship between the giver and recipient, and whether or not compensation was exchanged for the house, quitclaim deeds may still have gift tax consequences.

Creating a life estate 

A life estate is typically used to transfer property when the grantor wants to avoid the drawn-out process of validating a deceased person’s will and carrying out its terms (this process is known as probate). 

In terms of tax implications, a life estate is considered a gift of real property. The grantor has to fill out a gift tax form, but they only have to pay the gift tax if the amount puts them over the $12.06 million lifetime exemption. 

By creating a life estate, a homeowner establishes joint ownership of the property with another individual, but they retain the right to use the property and continue to be responsible for any ongoing expenses, like the mortgage, property taxes and insurance.

When the original owner dies, the beneficiary they added to the deed receives full ownership rights to the property.

One thing to note about a life estate is that it limits the original owner’s ability to make decisions about the property. While the original owner retains rights of use, they cannot sell, rent out or take a loan against the property unless the beneficiary agrees in writing.

What to Know Before You Gift: Capital Gains Tax

The real estate gift tax applies to homeowners who gift their homes to someone else. But the recipient of the real estate might be on the hook for a different type of tax – capital gains tax. 

What is capital gains tax?

You pay capital gains tax when you sell an asset for a profit. For example, if you buy a house for $250,000 and sell it for $600,000, that sale price represents a capital gain of $350,000, which may be taxable as capital gains. Capital gains tax comes in two forms: short-term capital gains and long-term capital gains.

Short-term capital gains

Short-term capital gains are taxes you pay when you profit from the sale of an asset you owned for less than 1 year. Short-term capital gains are subject to ordinary income tax, so you’ll pay the same tax rate you would if you earned that money as income. Short-term capital gains tax is higher than long-term capital gains tax.

Long-term capital gains

Long-term capital gains are taxes you pay when you profit from the sale of an asset you owned for one year or longer. Long-term capital gains tax rates vary from 0% to 20%.[5] Long-term capital gains taxes are lower than short-term capital gains taxes, incentivizing people to hold their assets for at least a year.

Cost basis

As a recipient of gifted real estate, you’ll only have to pay capital gains tax if you sell the property for a profit. But since you didn’t buy the property, how does the IRS know if you’ve made a profit or not? The answer to this question lies in the cost basis, which is the price at which the asset was acquired. 

If you receive property as a gift from someone who’s still living, your cost basis will be the price they originally paid for the property. So if your parents want to give you a house they bought in 1985 for $180,000, your cost basis is $180,000. 

Step-up cost basis savings

To help the recipient of gifted real estate minimize the amount of capital gains tax they owe, some people take advantage of the IRS’s stepped-up cost basis. This only applies to real estate gifted after death (as we saw with the example of a life estate). 

With the stepped-up cost basis, the IRS will use the fair market value of the property at the time of the deed transfer, rather than the original purchase price. This way, if your parents give you the house they purchased for $180,000 in 1985 that’s worth $700,000 today, capital gains tax would only kick in if you sold the house for more than $700,000. 

How To Avoid Capital Gains Tax on Gifted Property

The best way to avoid capital gains tax on gifted property is to live in the property for at least 2 of the 5 years before you sell. The IRS allows single tax filers to exclude the first $250,000 in gains from the sale of your home (or up to $500,000 for married couples filing jointly). Remember, you have to live in the home for at least 2 of the last 5 years before selling, though those 2 years don’t have to be consecutive.[6]

A Gift with Strings Attached

The gift of real estate is one that will endure, but it comes with certain stipulations for both the giver and recipient. For most people, gifting real estate won’t result in having to pay any taxes, but you’ll still be required to file the gift with the IRS if it exceeds the annual exclusion limits. 

Before you gift property to someone, speak to a tax professional or attorney to discuss your options.

  1. Internal Revenue Service. “Frequently Asked Questions on Gift Taxes.” Retrieved July 2022 from https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes

  2. Internal Revenue Service. “About Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.” Retrieved July 2022 from https://www.irs.gov/forms-pubs/about-form-709

  3. Internal Revenue Service. “What’s New – Estate and Gift Tax.” Retrieved July 2022 from https://www.irs.gov/businesses/small-businesses-self-employed/whats-new-estate-and-gift-tax

  4. Internal Revenue Service. “Instructions for Form 706.” Retrieved July 2022 from https://www.irs.gov/instructions/i706#f16779e20

  5. Internal Revenue Service. “Topic No. 409 Capital Gains and Losses.” Retrieved July 2022 from https://www.irs.gov/taxtopics/tc409

  6. Internal Revenue Service. “Publication 523 (2021), Selling Your Home.” Retrieved July 2022 from https://www.irs.gov/publications/p523#

ICYMI

In Case You Missed It

  1. Most people can avoid paying gift taxes by taking advantage of the IRS’s lifetime gift and estate tax exclusion

  2. The recipient of gifted real estate may be responsible for capital gains taxes when they sell the property

  3. Recipients of gifted real estate can avoid up to $250,000 of capital gains tax ($500,000 for joint filers) by living in the property for at least 2 of the 5 years before selling the home

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