Most parents take an interest in giving 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. However, 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 Real Estate Gift Tax? 

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 created 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. Something to keep in mind, the 2022 exemption for gifts is $16,000 per individual.  

Real estate is an asset that holds great significance for both homeowners and investors. It not only provides shelter but also serves as a long-term investment and a means of generating wealth. In some cases, individuals may consider gifting real estate to their loved ones as a gesture of generosity or as part of an estate planning strategy. However, it's essential to understand the implications of the real estate gift tax to avoid unnecessary costs. In this article, we will delve into the intricacies of the real estate gift tax and explore various strategies individuals can employ to minimize or avoid this tax burden altogether. 

It’s simple. 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. 

Even though there are many similarities between gift and estate tax, they are separate policies. 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. This is good news! Therefore, this means that less than 0.1% of U.S. taxpayers will need to worry about estate taxes. 

If you’re wondering how it works, let’s provide you with more context for how the real estate gift tax on property transfer works with the example below.  

Matt and Rachel who will serve as the fictional parents for this example, are currently in their mid-50s and plan on gifting a home to their adult child Arnold 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. 

If Matt and Rachel Have an Estate Worth More Than $25 Million And A House Worth $2 Million 

By applying the annual gift tax exemption of $16,000 per spouse (Matt and Rachel), given to other individuals (Arnold 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 for the estate tax exemption, and Matt and Rachel won’t pay any taxes on the transfer. However, they will use up part of their lifetime exemptions. 

If Matt and Rachel Have an Estate Worth $5 Million And A House Worth $300,000 

In this scenario, we’ll apply for 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. 

If The House Is the Bulk of Matt and Rachel’s Estate 

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

Longer-Term Consequences of Gifting: The Capital Gains Tax 

One other fact to consider is the cost of the gift Arnold will receive – namely, the price their parents paid for the property. If Arnold 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 Arnold sells the property, they will pay much more in the gift scenario, assuming what Matt and Rachel spent is far less than what Max will someday sell it for. 

Here’s What You Need to Know Before You Gift 

Before you consider 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. 

What Does Arnold Plan to Do With The Property? 

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 Arnold plans to sell the home quickly, they could get hit with a large capital gains tax bill. 

That’s because Arnold’s cost basis would be what their parents paid for the house, plus any closing costs and capital improvements. Whereas if Arnold 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. That is an ideal situation you want to be in, so consider it before making any further moves.  

What Do Matt 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 and your family decide on the most efficient path forward. 

Shift The Tax Burden 

Let’s say Matt and Rachel 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. 

Arnold can sell the house after holding it for over a year and avoid any capital gains taxes. However, Arnold needs to sell the house before their income rises above $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, however 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 consider consulting with an elder law attorney about protecting your assets before taking any action. 

What Are Some 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 reasonable 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, if you think you will retain control of the home think again. The original owners 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 Will Benefit Your Family in the Long-Run 

Another option to consider 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. 

Here Are Some Real Estate Gift Tax FAQs 

There are many different facets of real estate gift tax. Let’s dive into some of the most commonly asked questions regarding this topic. 

What IRS form should be used when paying taxes on gifted real estate? 

The short answer is Form 709. Transferring real estate incurs gift and inheritance taxes payable to the IRS. Remember, this does not include gifts for your spouse.  

What happens to title insurance when gifting real estate? 

Since the 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.  

Can someone take back the property they gave you? 

In most cases, no. If the real estate gift 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. 

Can I provide any type of real estate property? 

Yes! Almost any form of real estate is eligible to be gifted. This includes vacation homes, undeveloped properties, residences, commercial properties, and more. 

Can someone gift their home while still living in it? 

This is the most common option families use with older relatives 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. 

Here’s 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 Blogs section.