Most parents want to give their kids advantages they never had growing up. If you have the financial means, it may be appealing to think about gifting real estate to your child. 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.
According to the Internal Revenue Service (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 2022 exemption for gifts is $16,000 per individual.
It’s easy to get gift tax and 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 relevant for most .
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.
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 0.1% of U.S. taxpayers will need to worry about estate taxes.
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 Sam and Morgan. They are currently in their mid-50s and plan on gifting a home to their adult child Max and their spouse.
Unless the gift amount exceeds the entire estate exemption (which is $24.12 million for married couples in 2022), no taxes will be due on the gift. Keep in mind the exemption limit will decrease over the next few years due to federal law. Let’s look at a few different scenarios and how the gift tax might apply.
By applying the annual gift tax exemption of $16,000 per spouse (Sam and Morgan), given to other individuals (Max and spouse), that would equate to $32,000 each for Max and spouse, meaning the first $64,000 of the gift is gift tax-free. Next, we’ll apply the estate tax exemption, and Sam and Morgan won’t pay any taxes on the transfer. However, they will use up part of their lifetime exemptions.
In this scenario, we’ll apply the same $64,000 annual exemption. And once you use the estate tax exemption, there are no gift taxes to pay, but other tax problems could arise.
In this situation, the annual exemption will apply. Anything beyond that will come out of Morgan and Sam’s lifetime exemptions.
Another fact to consider is the cost of the gift Max will receive – namely, the price their parents paid for the property. If Max inherited the home after their parents’ deaths, they would be entitled to a step-up in 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 Max sells the property, they will pay much more in the gift scenario, assuming what Sam and Morgan spent is far less than what Max will someday sell it for.
Before gifting property to another person, there are many things you should think about first. Several scenarios can cause unintended tax consequences and should be considered before the gift is made or estate planning is finalized; you can speak with a tax advisor for more details.
When you gift another person real estate property, the recipient’s plans to sell or stay are crucial to determining a course of action. For instance, if Max plans to sell the home quickly, they could get hit with a large capital gains tax bill.
That’s because Max’s cost basis would be what their parents paid for the house, plus any closing costs and capital improvements. Whereas if Max plans to keep the home in the family indefinitely, they can pass it to their children at their death and avoid capital gains taxes altogether during their lifetime.
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.
Let’s say Morgan and Sam wish to provide their 20-year-old child – 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.
Max can sell the house after holding it for over a year and avoid any capital gains taxes. However, Max needs to sell the house before their income rises above $40,000 annually.
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.
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.
If you’re looking for ways to avoid the gift tax, here are some good alternatives to gifting real estate.
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.
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.
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.
There are many different facets of real estate gift tax. Let’s dive into some of the most commonly asked questions regarding this topic.
The short answer is Form 709. Transferring real estate incurs gift and inheritance taxes payable to the IRS. Keep in mind this does not include gifts to your spouse.
Since title insurance can’t be gifted alongside the property, the new owner will need to pay for title insurance on the property themselves. The only way title insurance remains is if the new owner is inheriting the property from a will.
If the real estate gifted is legal on all counts then it cannot be revoked from the person who is receiving it. This is why legal paperwork is an important part of the gift real estate process.
Yes! Almost any form of real estate is eligible to be gifted. This includes vacation homes, undeveloped property, residence, commercial properties and more.
This is common with older family members who are often looking for some sort of living assistance. Using revocable living trusts is something families can use to manage the property after the older family member passes away.
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.
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.
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