:max_bytes(150000):strip_icc()/young-man-cleaning-house-with-vacuum-cleaner-964867220-e348c5ffb9774abf8f62ca75f19cb2b1.jpg?ssl=1 "Selling Gifted Real Estate Can Have Capital Gains Tax Consequences")
Gifting real estate can come with a few disadvantages from a tax perspective, depending on what the recipient does with the property. A capital gains tax can come into play.
Some tax professionals advise people to never give real estate. That might be a little extreme because there are some scenarios where it can be a smart tax move, but there are many considerations depending on how and when you’re giving the gift.
Key Takeaways
- Two tax considerations come into play with gifted property: the estate tax and capital gains tax.
- Estates must pay tax on estates valued at more than $13.61 million for deaths that occurred in 2024.
- Capital gains taxes are determined by the property’s cost basis, which is the value of the asset when purchased (if given as a gift) or when transferred (if inherited).
Effect of Estate Taxes on Inherited Property
The executor of a decedent’s estate will typically value all the property owned by the individual as of the date of death, then do so again six months later. The executor can then use the valuation that results in the least possible estate tax consequences—the lesser the value, the better.
The goal is that the estate’s entire value will be less than the year’s federal estate tax exemption so no estate tax will be owed. Estates must pay the federal estate tax on values over $13.61 million for deaths that occur in tax year 2024. For 2023 the exemption was $12,920,000.
The majority of estates are never subject to this tax because the exemption is so high, but this could change if the exemption drops significantly, as it might when the Tax Cuts and Jobs Act expires after 2025.
Capital Gains Tax Considerations
It’s generally better to receive real estate as an inheritance rather than as an outright gift because of capital gains implications. That’s because of the cost basis, which is the cost of the property used to determine the capital gain, if any, when it is transferred.
When Real Estate Is Inherited
Your cost basis in the property as an heir would be the fair market value of the real estate on the executor’s chosen valuation date, not its initial purchase price when the decedent acquired it. The executor may also choose to use the date of death as the basis valuation date. Either way, this adjustment is called a “stepped-up basis,” and it’s an excellent way to minimize your capital gains tax liability if you decide to sell the property after you inherit it.
Note
The deceased probably paid much less for the property than its fair market value in the year of death if they owned the real estate for any length of time.
As an example, you’d have no capital gain if the decedent gave you real estate worth $350,000 as of the estate’s valuation date and you immediately sold that property for $350,000. But you’d have a capital gain of $250,000 if you inherited the deceased’s tax basis and they bought that property for $100,000 decades ago and gave it to you as an outright gift during their lifetime: the difference between the $100,000 basis and your sales price.
The greater the estate tax valuation, the less amount of profit will be subject to capital gains tax if you should decide to sell the real estate.
When Real Estate Is Given as a Gift
Your cost basis would be the same as the donor’s cost basis if you received the property as a gift during the donor’s lifetime because there’s no step-up in basis. If the donor purchased the property for $100,000, then your cost basis would be $100,000, even if the property is now worth $350,000.
Note
Review your “adjusted cost basis” in the property as well, because your cost basis can be reduced even more by any depreciation the donor might have claimed or could have claimed as tax deductions over the years.
Again, the lower your basis is, the greater your gain will be if and when you sell the home.
Long-Term Capital Gains Tax Rates
You’d pay a long-term capital gains tax on the difference between the cost basis and the sale amount if you owned the property for more than a year before selling and you earned more than certain thresholds. Below these thresholds, you’d pay no capital gains tax.
| 0% Capital Gains Thresholds | |
|---|---|
| Filing Status | 0% Income Thresholds for 2024 |
| Single | $44,625 |
| Married Filing Jointly | $89,250 |
| Head of Household | $59,750 |
Taxpayers will pay 15% in long-term capital gains tax if they exceed these income thresholds. For instance, this could result in a capital gains tax bill of $37,500 if you sold that $100,000 property for its $350,000 current fair market value: $350,000 less your $100,000 basis ($250,000) times 15%.
At very high income thresholds, the long-term capital gains tax rate increases. Beyond these thresholds, long-term capital gains are taxed at the short-term rate (20%).
| 15% Income Capital Gains Thresholds | |
|---|---|
| Filing Status | 15% Income Thresholds for 2024 |
| Single | $492,300 |
| Married Filing Jointly | $553,850 |
| Head of Household | $523,050 |
When Short-Term Capital Gains Tax Rates Make Sense
Most taxpayers are better off with long-term rates than short-term capital gains tax rates. You pay a short-term capital gain of 20% if you sell the real estate after you’ve owned it for one year or less. For many taxpayers that’s less than the tax rate for ordinary income, which can be more than 20%.
When Gifting Can Be a Good Thing
The loss of the stepped-up basis makes gifting during your lifetime a less favorable way of transferring assets, but it can still be an excellent strategy for shifting capital gains before the sale of a property to a family member whose income is subject to lower tax rates.
For example, that family member could earn up to $44,625 in 2024 without paying any capital gains tax if they were single and held onto the property for more than a year. Gifting the property would be a way of choosing a more favorable tax rate on appreciated investments before a potential sale.
What to Do If You’ve Been Given Real Estate
You have a few options if you’ve already received property as a gift:
- You can simply keep the gift. You’ll be on the hook for taxes if you sell the property, but the basis will step up for your heirs if you hold onto it until you die. They can then sell it and shelter some of the capital gains.
- You can give the property back. The donor’s cost basis would be the same as your cost basis, which means it would be their original cost basis as adjusted for depreciation. They could then potentially leave the property to you as an inheritance instead.
- Finally, you can give the property to someone else, perhaps your child or another relative. Choose someone who wouldn’t be subject to capital gains tax based on their income if they should sell. You might also give it to a charity, which can take all the gains tax-free and you’ll get an itemized tax deduction, subject to certain rules.
Frequently Asked Questions (FAQs)
What IRS form do you use when paying taxes for a gifted property?
You will file IRS Form 709 to report gifts that trigger the gift tax.
What documents do you use when gifting property to children?
When you’re giving property to family members as a gift, you can use a gift deed to transfer ownership.