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Understanding the Tax Implications of Inheriting or Receiving a Home as a Gift

by with No Comment Tax, Real Estate, Private Wealth

A frequent question, and a situation where taxpayers often make tax mistakes, is whether it is better to receive a home as a gift or as an inheritance. It is generally more advantageous tax-wise to inherit a home rather than to receive it as a gift before the owner’s death. This article will explore the various tax aspects related to gifting a home, including gift tax implications, basis considerations for the recipient, and potential capital gains tax implications. Here are the key points that highlight why inheriting a home is often the better option.

RECEIVED AS A GIFT 

First let’s explore the tax ramifications of receiving a home as a gift. Gifting a home to another person is a generous act that can have significant implications for both the giver (the donor) and the recipient (the donee), especially when it comes to taxes. Most gifts of this nature are between parents and children. Understanding the tax consequences of such a gift is crucial for anyone considering this option.  

Gift Tax Implications – When a homeowner decides to gift their home to another person (whether or not related), the first tax consideration is the federal gift tax. The Internal Revenue Service (IRS) requires individuals to file a gift tax return if they give a gift exceeding the annual exclusion amount, which is $18,000 per recipient for 2024. This amount is inflation adjusted annually. Where gifts exceed the annual exclusion amount, and a home is very likely to exceed this amount, it will necessitate the filing of a Form 709 gift tax return.

It’s worth mentioning that while a gift tax return may be required, actual gift tax may not be due thanks to the lifetime gift and estate tax exemption. For 2024, this exemption is $13.61 million per individual, meaning a person can gift up to this amount over their lifetime without incurring gift tax. The value of the home will count against this lifetime exemption. 

Note: The lifetime exclusion was increased by the Tax Cuts and Jobs Act (TCJA) of 2017, which without Congressional intervention will expire after 2025, and the exclusion will get cut by about half.   

Basis Considerations for the Recipient – For tax purposes basis is the amount you subtract from the sales price (net of sales expenses) to determine the taxable profit. The tax basis of the gifted property is a critical concept for the recipient to understand. The basis of the property in the hands of the recipient is the same as it was in the hands of the donor. This is known as “carryover” or “transferred” basis. 

For example, if a parent purchases a home for $200,000 and later gifts it to their child when its fair market value (FMV) is $500,000, the child’s basis in the home would still be $200,000, not the FMV at the time of the gift. If during the parent’s time of ownership, the parent had made improvements to the home of $50,000, the parent’s “adjusted basis” at the time of the gift would be $250,000, and that would become the starting basis for the child.

If a property’s fair market value (FMV) at the date of the gift is lower than the donor’s adjusted basis, then the property’s basis for determining a loss is its FMV on that date.

This carryover basis can have significant implications if the recipient decides to sell the home. The capital gains tax will be calculated based on the difference between the sale price and the recipient’s basis. If the home has appreciated significantly since it was originally purchased by the donor, the recipient could face a substantial capital gains tax bill upon sale.

Home Sale Exclusion – Homeowners who sell their homes may qualify for a $250,000 ($500,000 for married couples if both qualify) home gain exclusion if they owned and used the residence for 2 of the prior 5 years counting back from the sale date. However, when a home is gifted that gain qualification does not automatically pass on to the gift recipient. To qualify for the exclusion the recipient would have to first meet the 2 of the prior 5 years qualifications. Thus, where the donor qualifies for home gain exclusion it may be best taxwise for the donor to sell the home, taking the gain exclusion and gift the cash proceeds net of any tax liability to the donee.  

Of course, there may be other issues that influence that decision such as the home being the family home that they want to remain in the family.  

Capital Gains Tax Implications – The capital gains tax implications for the recipient of a gifted home are directly tied to the basis of the property and the holding period of the donor. If the recipient sells the home, they will owe capital gains tax on the difference between the sale price and their basis in the home. Given the carryover basis rule, this could result in a significant tax liability if the property has appreciated since the donor originally purchased it. Capital gains are taxed at a more favorable rate if the property has been held for over a year. For gifts the holding period is the sum of the time held by the donor and the donee, sometimes referred to as a tack-on holding period.

Special Considerations – In some cases, a homeowner may transfer the title of their home but retain the right to live in it for their lifetime, establishing a de facto life estate. In such situations, the home’s value is included in the decedent’s estate upon their death, and the beneficiary’s basis would be the FMV at the date of the decedent’s death, potentially offering a step-up in basis and significantly reducing capital gains tax implications, i.e., treated as if they inherited the property.

AS AN INHERITANCE

There are significant differences between receiving a property as a gift or by inheritance.  

Basis Adjustment – When you inherit a home, your basis in the property is generally “stepped up” to the fair market value (FMV) of the property at the date of the decedent’s death. However, occasionally this could result in a “step-down” in basis where a property has declined in value. Nevertheless, this day and age, most real estate would have appreciated in value over the time the decedent owned it, and the increase in value will not be subject to capital gains tax if the property is sold shortly after inheriting it. 

For example, if a home was purchased for $100,000 and is worth $300,000 at the time of the owner’s death, the inheritor’s basis would be $300,000. If the inheritor sells the home for $300,000, there would be no capital gains tax on the sale.

In addition, the holding period for inherited property is always considered long term, meaning inherited property gain will always be taxed at the more favorable long-term capital gains rates. 

Note: The Biden administration’s 2025–2026 budget proposal would curtail the basis step-up for higher income taxpayers.  

In contrast, if a property is received as a gift before the owner’s death, the recipient’s basis in the property is the same as the giver’s basis. This means there is no step-up in basis, and the recipient could face significant capital gains tax if the property has appreciated in value, and they decide to sell it. 

Using the same facts as in the example just above, if the home was gifted and had a basis of $100,000, and the recipient later sells the home for $300,000, they would potentially face capital gains tax on the $200,000 increase in value.

Depreciation Reset – For inherited property that has been used for business or rental purposes, the accumulated depreciation is reset, allowing the new owner to start depreciation afresh on the inherited portion and since the inherited basis is FMV at the date of the decedent’s death, the prior depreciation is disregarded. This is not the case with gifted property, where the recipient takes over the giver’s depreciation schedule.

Given these points, while each situation is unique and other factors might influence the decision, from a tax perspective, inheriting a property is often more beneficial than receiving it as a gift. However, it’s important to consider the overall estate planning strategy and potential non-tax implications. 

Please contact this office for developing a strategy that is suitable for your specific circumstances.  

Real estate and Gift new home concept,Model house with Red ribbon and key on black background

Gift and Estate Tax Primer

by with No Comment Tax, Real Estate, Private WealthAdvisory, Real Estate

The tax code places limits on the amounts that individuals can gift to others (as money or property) without paying taxes. This is meant to keep an individual from using gifts to avoid the estate tax that is imposed upon the assets owned by the individual at their death. This can be a significant issue for family-operated businesses when the business owner dies; such businesses often must be sold to pay the resulting estate taxes. This is, in large part, why high-net-worth individuals invest in estate planning. 

Exclusions – Current tax law provides both an annual gift tax exclusion and a lifetime exclusion from the gift and estate taxes. Because the two taxes are linked, gifts that exceed the annual gift tax exclusion reduce the amount that the giver can later exclude for estate tax purposes. The term exclusion means that the amount specified by law is exempt from the gift or estate tax.

Annual Gift Tax Exclusion – This inflation-adjusted exclusion is $18,000 for 2024 (up from $17,000 for 2023). Thus, an individual can give $18,000 each to an unlimited number of other individuals (not necessarily relatives) without any tax ramifications. When a gift exceeds the $18,000 limit, the individual must file a Form 709 Gift Tax Return. However, unlimited amounts may be transferred between spouses without the need to file such a return – unless the spouse is not a U.S. citizen. Gifts to noncitizen spouses are eligible for an annual gift tax exclusion of up to $185,000 in 2024 (up from $175,000 in 2023).

Example: Jack has four adult children. In 2024, he can give each child $18,000 ($72,000 total) without reducing his lifetime exclusion or having to file a gift tax return. Jack’s spouse can also give $18,000 to each child without reducing either spouse’s lifetime exclusion. If each child is married, then Jack and his wife can each also give $18,000 to each of the children’s spouses (raising the total to $72,000 given to each couple) without reducing their lifetime gift and estate tax exclusions. The gift recipients (termed “donees”) are not required to report the gifts as taxable income and do not even have to declare that they received the gifts on their income tax returns. 

If any individual gift exceeds the annual gift tax exclusion, the giver must file a Form 709 Gift Tax Return. However, the giver pays no tax until the total amount of gifts more than the annual exclusion exceeds the amount of the lifetime exclusion. The government uses Form 709 to keep track of how much of the lifetime exclusion an individual has used prior to that person’s death. If the individual exceeds the lifetime exclusion, then the excess is taxed; the current rate is 40%.

All gifts to the same person during a calendar year count toward the annual exclusion. Thus, in the example above, if Jack gave one of his children a check for $18,000 on January 1, any other gifts that Jack makes to that child during the year, including birthday or Christmas gifts, would mean that Jack would have to file a Form 709.

Gifts for Medical Expenses and Tuition – An often-overlooked provision of the tax code allows for nontaxable gifts in addition to the annual gift tax exclusion; these gifts must pay for medical or education expenses. Such gifts can be significant; they include.

  • tuition payments made directlyto an educational institution (whether a college or a private primary or secondary school) on the donee’s behalf – but not payments for books or room and board – and
  • payments made directly to any person or entity who provides medical care for the donee.

In both cases, it is critical that the payments be made directly to the educational institution or health care provider. Reimbursements to the donee do not qualify. 

Lifetime Exclusion from Gift and Estate Taxes – The gift and estate taxes have been the subject of considerable political bickering over the past few years. Some want to abolish this tax, but there has not been sufficient support in Congress to do that; instead, the lifetime exclusion amount was nearly doubled as of 2018 and has been increased annually due to an inflation-adjustment requirement in the law. In 2024, the lifetime exclusion is $13.61 million per person. By comparison, in 2017 (prior to the tax reform that increased the exemption), the lifetime exclusion was $5.49 million. The lifetime estate tax exclusion and the gift tax exclusion have not always been linked; for example, in 2006, the estate tax exclusion was $2 million, and the gift tax exclusion was $1 million. The tax rates for amounts beyond the exclusion limit have varied from a high of 46% in 2006 to a low of 0% in 2010. The 0% rate only lasted for one year before jumping to 35% for a couple of years and then settling at the current rate of 40%. 

This history is important because the exclusions can change significantly at Congress’s whim – particularly based on the party that holds the majority. In fact, absent Congressional action, the exclusion amount is scheduled to return to the 2017 amount, adjusted for inflation, in 2026, estimated to be just over $6 million per person.

Spousal Exclusion Portability – When one member of a married couple passes away, the surviving member receives an unlimited estate tax deduction; thus, no estate tax is levied in this case. However, as a result, the value of the surviving spouse’s estate doubles, and there is no benefit from the deceased spouse’s lifetime unified tax exclusion.  For this reason, the tax code permits the executor of the deceased spouse’s estate (often, the surviving spouse) to transfer any of the deceased person’s unused exclusion to the surviving spouse. Unfortunately, this requires filing a Form 706 Estate Tax Return for the deceased spouse, even if such a return would not otherwise be required. This form is complicated and expensive to prepare, as it requires an inventory with valuations of all the decedent’s assets. As a result, many executors of relatively small estates skip this step. As discussed earlier, the lifetime exclusion can change at the whim of Congress, so failing to take advantage of this exclusion’s portability could have significant tax ramifications. 

Qualified Tuition Programs – Any discussion of the gift and estate taxes needs to include a mention of qualified tuition programs (commonly referred to as Sec 529 plans, after the tax code section that authorizes them). These plans are funded with nondeductible contributions, but they provide tax-free accumulation if the funds are used for a child’s postsecondary education (as well as, in many states, up to $10,000 of primary or secondary tuition per year). Contributions to these plans, like any other gift, are subject to the annual gift tax exclusion. Of course, these plans offer tax-free accumulation when distributions are made for eligible education expenses, so it is best to contribute funds as soon as possible. 

Under a special provision of the tax code, in a given year, an individual can contribute up to 5 times the annual gift tax exclusion amount to a qualified tuition account and can then treat the contribution as having been made ratably over a five-year period that starts in the calendar year of the contribution. However, the donor then cannot make any further contributions during that five-year period. 

Basis of Gifts – Basis is the term for the value (usually cost) of an asset; it is used to determine the profit when an asset is sold. The basis of a gift is the same for the donee as it was for the donor, but this amount is not used for gift tax purposes; instead, the fair market value as of the date the gift is made is used.

Example: In 2024, Pete gifts shares of stock to his daughter. Pete purchased the shares for $6,000 (his basis), and they were worth $25,000 in fair market value when he gifted them to his daughter. Their value at the time of the gift is used to determine whether the gift exceeds the annual gift tax exclusion. Because the gift’s value ($25,000) is greater than the $18,000 exclusion, Pete will have to file a Form 709 Gift Tax Return to report the gift; he also must reduce his lifetime exclusion by $7,000 ($25,000 – $18,000). His daughter’s basis is equal to the asset’s original value ($6,000); when she sells the shares, her taxable gain will be the difference between the sale price and $6,000. Thus, Pete has effectively transferred the tax on the stock’s appreciated value to his daughter. 

If Pete’s daughter instead inherited the shares upon Pete’s death, her basis would be the fair market value of the stock at that time (let’s say it is $28,000) and if she sold the shares for $28,000, she would have no taxable gain. 

This is only an overview of the tax law regarding gifts and estates; please call this office for further details or to get advice for your specific situation. 

What Do New Tangible Property Rules Mean to You?

by with No Comment Tax, Real Estate, Private Wealth

Businesses often wrestle with understanding what items should be deducted versus what should be expensed. That task got a little more complicated this year when the Internal Revenue Service finalized new tangible property rules. They affect every business that has tangible property–buildings, machinery, equipment, furniture, vehicles‚Äîso they‚Äôre pretty far reaching. And they add a new layer of complexity to your tax planning.

We can help you address the new requirements, which may include determining whether you need to complete additional paperwork to request a change in accounting method. Be sure to contact us to learn about handling this and any other tax law changes that may affect your business.