Real estate gifts tax are a wonderful way to express your affection and preserve a family home. However, giving away property may have some tax repercussions, such as the federal gift tax.
You can get a house as a gift from your parents, grandparents, or anybody else as long as they fill out a gift tax return form and pay all associated taxes. We’re here to help you learn everything you need to know about the gift tax on property and how you might be able to avoid it. Gift taxes on real estate can be difficult and expensive.
What Is the Real Estate Gift Tax and How Can I Avoid It?
What Is the Gift Tax on Real Estate?
Every time a property is transferred to another party for less than the full market worth of the home or for nothing at all, the Internal Revenue Service (IRS) levies a gift tax on the homeowner. The gift tax form, commonly known as Form 708, is required to be filed by all US citizens and residents who donate gifts totaling more than $17,000 in a calendar year.[1] [2]
Gift-giving is not something that the IRS gift tax is intended to stop. Instead, it exists to assist the government in stopping citizens from avoiding paying taxes when transferring money. For instance, you will be liable for gift tax if you give someone property during your lifetime.
Despite the fact that gifts are legally taxed, there is a $12.92 million per person lifetime exemption from gift and estate taxes set by the IRS for the 2023 tax year.[3] As a result, you are exempt from paying taxes on gifts worth up to $12.92 million that you make to others.
Just keep in mind that this sum includes both the gifts you make while you are still alive and the legacies you leave behind when you pass away. The $12.92 million exemption limit only applies to big gifts (those over $17,000 for 2023) since the IRS does not intend to tax every dollar you give to someone else.
Estate tax versus gift tax
Because they have the same federal tax rate and lifetime exclusion, federal gift taxes and federal estate taxes are frequently misunderstood. The main distinction is that gift tax is imposed while you are alive, whereas estate tax is imposed following your passing.
What is the Process of Gift Tax?
For the person giving the house (also known as the grantor), there may be some tax repercussions when giving it as a gift. The purpose of the gift tax was already discussed. Let’s now examine the federal government’s gift tax system, including who is responsible for paying it and how much it may total.
When is there a gift tax?
For 2023, gifts of real estate valued at more than $17,000 (or $34,000 for married couples) are subject to federal gift tax.[1] Remember that the IRS reserves the right to modify this number in the future.
In addition, gift taxes may be imposed regardless of purpose. The gift tax may apply to even seemingly unrelated items, such as your parents’ offer to sell you their home at market value in exchange for a loan with no interest.
Gift tax is paid by who?
The person who owns the home and is transferring some or all of the property to someone else is responsible for paying the gift tax when it comes to real estate. Even if the grantor doesn’t end up owing any tax money as a result, they still need to complete Form 709 and send it to the IRS if the amount of the gift is less than the lifetime estate and gift exclusion allowed by the IRS.
What is the gift tax rate?
The starting gift tax rate is 18%, and the maximum rate is 40%. Gift taxes are progressive, meaning the more money you give, the higher the tax rate will be.[4]
How Can I Avoid the Real Estate Gift Tax?
An example of the gift tax
Congratulations on your newly born child, you and your spouse! To avoid having to deal with stairs and snow, your parents intend to move into a condo. Additionally, they want to sell you their home at a significant discount because you’ve been looking at houses in their neighborhood already.
Though your parents’ house is worth $900,000, they’re willing to sell it to you for just $350,000. Your parents are essentially giving you a $550,000 gift of equity in the eyes of the law. Even though you are buying the home from your parents, it is still regarded as a taxable gift, necessitating the completion and submission of Form 709.
How Can Gift Tax Be Avoided?
In many cases, you can avoid paying gift tax by taking advantage of the IRS’ annual and lifetime exclusions.
Annual gift tax exclusion
If the gift is under the annual limit, the annual gift tax exclusion enables the giver to avoid paying taxes or submitting Form 709 to the IRS. For 2023, the IRS annual gift tax exclusion is $17,000 for individuals or $34,000 for married couples filing jointly.[1]
Gift tax lifetime exclusion
If you give someone a gift exceeding $17,000, 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 2023, the lifetime gift tax exclusion is $12.92. million.[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 residence at fair market value
The IRS routinely scrutinizes non-arm’s length transactions, which are dealings that occur between parties 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 common means to transfer property swiftly, but it’s normally 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 transferred for the residence, quitclaim deeds may nevertheless have gift tax repercussions.
Creating a life estate
A life estate is generally used to transfer property when the grantor wants to bypass the drawn-out process of validating a deceased person’s will and carrying out its contents (this process is known as probate).
A life estate is regarded as a gift of real property for tax purposes. The grantor must complete a gift tax form, but they are only required to pay the gift tax if the value exceeds their lifetime exemption of $12.92 million.
By creating a life estate, a homeowner establishes joint ownership of the property with another individual, but they retain the ability to use the property and continue to be responsible for any ongoing obligations, such the mortgage, property taxes and insurance.
When the original owner dies, the beneficiary they added to the deed obtains complete ownership rights to the property.
One thing to note about a life estate is that it limits the original owner’s power to make decisions concerning the property. While the original owner retains rights of use, they cannot sell, rent out or take a loan on the property unless the beneficiary agrees in writing.
What to Know About Capital Gains Tax Before You Give
Homeowners who give their properties as gifts to others are subject to the real estate gift tax. But the recipient of the real estate can be on the line for a different form of tax — capital gains tax.
What is capital gains tax?
You pay capital gains tax when you sell an asset for a profit. For instance, if you purchase a house for $250,000 and sell it for $600,000, the $350,000 in capital gain that results from the sale may be subject to capital gains tax. Long-term capital gains and short-term capital gains are the two types of capital gains tax.
gains made recently
When you make money from the sale of an asset that you owned for less than a year, you must pay taxes on your short-term capital gains. Since short-term capital gains are subject to ordinary income tax, your tax rate will be the same as it would be if you had actually earned the money. The tax rate on capital gains is higher for short-term gains than for long-term gains.
profits made over the long run
When you make money from the sale of an asset you owned for more than a year, you must pay taxes on your long-term capital gains. Tax rates on long-term capital gains range from 0% to 20%.[5] Long-term capital gains taxes are lower than short-term capital gains taxes, motivating people to retain their assets for at least a year.
a cost-based approach
If you get real estate as a gift, you won’t be subject to capital gains tax unless you later sell the property for a profit. But how can the IRS tell if you’ve made a profit or not because you didn’t purchase the property? The cost basis, or the cost at which the item was purchased, provides the answer to this query.
Your cost basis for property you receive as a gift from a person who is still alive is the amount they originally paid for it. So if your parents wish to give you a house they bought in 1985 for $180,000, your cost basis is $180,000.
cost basis savings with a boost
To help the beneficiary of gifted real estate decrease the amount of capital gains tax they owe, some persons take advantage of the IRS’s stepped-up cost basis. As we saw with the example of a life estate, this only applies to real estate that is given after death.
Instead of using the initial purchase price when calculating the stepped-up cost basis, the IRS will use the property’s fair market value at the time of the deed transfer. Capital gains tax would only apply if you sold the house for more than $700,000 if your parents gave you the house they bought for $180,000 in 1985 and is now worth $700,000.
How to Reduce the Tax on Capital Gains from Gifted Property
Living in the property for at least two of the five years prior to sale is the greatest approach to avoid paying capital gains tax on donated property. The IRS permits single taxpayers to exclude up to $500,000 ($250,000 for married couples filing jointly) of the first $250,000 in gains from the sale of their house. Although those two years don’t have to be consecutive, you must have lived in the house for at least two of the previous five years before selling.[6]
A Present with Conditions
Real estate is a present that will always be appreciated, but there are some conditions that apply to both the giver and the recipient. Most people won’t have to pay taxes when they gift real estate, but if the present exceeds the yearly exclusion limitations, you’ll still need to submit a gift tax return with the IRS.
Before giving someone property, consider your choices with a tax expert or lawyer.
