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William Perez

The Gift of Real Estate: Generosity Can Be Taxing

By February 21, 2006

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Today's tax question comes from Beverly in Atlanta, Georgia. She asks, "My dad, 90 yrs.old and in apparent good health, gave me his rental condo in Florida in 1999. I have been renting it to vacationers since 1999. The condo was originally purchased in 1975 for $65,000 and is now valued at $550,000. I am an only child and will inherit everything at my dad's passing. This condo is the most valuable asset in the family. My father's only other assets total about $250,000. I also own my prinicipal residence in Atlanta, valued at about $475,000."

"My question is: Did he make a terrible financial mistake by giving me this condo instead of leaving it to me in his will? I have been told that if I sell, which is likely in about 2 yrs., that I will have to pay thousands in capital gains tax, whereas if I had inherited it, I would not have. I have two sons who will inherit everything I have. Now, should I 'sell' condo back to my dad to avoid the taxes should I sell it. Then, if I decided he needed to sell it in next year or so, would he pay taxes only on the difference of the present day value ($550,000) and whatever he got above that amount?"

"But, if I sell it back to him, to avoid the capital gains taxes, and I inherited it when he passes, THEN I sold it, what amount would I pay taxes on??? I need to know what to do in order to pay the least amount of taxes to Uncle Sam. When I mentioned to my accountant that my dad had just given me the condo, he said, "you know that was a big mistake, tax wise." What are the repercussions - tax wise - of all my options??? Thank you very much."

Giving the gift of real estate, while immensely generous, often comes with several disadvantages from a tax perspective. Some tax professionals advise people never to give real estate. I think that sounds a little too harsh, because I can imagine scenarios where giving real estate can be a smart tax move. However, this is not one of those situations.

Capital gains on gifts vs. inheritances
In general, you should prefer inheritances rather than gifts of real estate. Here's why. At death, the executor of your father's estate will value all the property in the estate. The executor will also value all the property again six months after the date of death. The executor will then choose whichever valuation date results in the least possible tax consequences. As an heir, your cost basis in the property will be the fair market value on the chosen valuation date. This is called "stepped-up basis," and generally provides an excellent way to minimize your taxes when you later sell the property.

In a gift situation, the recipient's cost basis is the same as the donor's cost basis. This makes gifting a slightly less favorable way of transferring assets. However, gifting can be an excellent strategy for shifting capital gains to family members with lower tax rates. For example, let's say you are sitting on long-term capital gains on some stocks, and those gains would be taxed at 15%. You can gift those stocks to another family member with little or no income, and the gains could be taxed at the lower 5% rate. The taxable amount of the gain is the same in either situation, so gifting is simply a way of choosing a more favorable tax rate on appreciated investments.

Capital gains on rental property
With regard to the rental property, your cost basis in the gifted property is the same as your father's cost basis. So if your dad purchased the property for $65,000, that's your cost basis as well. You'll need to carefully review your "adjusted cost basis" in the property (I provide the formula in my article on Reporting Rental Income on Schedule E.) In particular, you reduce your cost basis by the amount of depreciation you and your father claimed, or could have claimed, as a deduction. This will decrease your cost basis even further. Furthermore, the gains on the rental property will be taxed at two different tax rates: ordinary income tax rates on the amount of the gain attributed to depreciation, and long-term capital gains tax rates on any gain leftover after depreciation has been accounted for. This is called "depreciation recapture," as was the topic of a previous tax question of the day.

What to do now
What you should do now depends entirely on how long you plan to keep the rental property. If you are going to keep the property for the rest of your life and pass it on to your children as an inheritance, then there's really nothing you need to do right now. However, you indicated you might want to sell the property in the next few years. Someone will have to pay the tax on the gains, either your father or you or someone else. You should sit down with a tax professional and plan out the tax consequences of various strategies, and find out which strategy will save the least amount of tax.

Your possibilities include:

  • Undo the gift. Not sure if this can be undone after so many years have passed since the original gift.
  • Give the property back to the father. His cost basis will be the same as your cost basis, which is to say that it is your father's original cost basis, as adjusted for depreciation and other factors. Your father could then sell the property, or hold it until he dies.
  • Give the property to someone else. Perhaps your children or other relatives. The idea here to choose the tax rate with the most favorable tax consequences.
  • Give the property to charity, and let them take all the gains tax-free.
Those are your major options. Again, it all depends on what you want to do with the property, and over what time frame you plan to sell. An experienced tax professional can "run the numbers" on various tax scenarios and advise you on the best strategy for your situation.

Throughout the tax season I will be answering one tax question per day. Do you have a question? Visit the Ask a Tax Question page. Disagree with my answers? Post your comments in the Tax Forum.

Comments
July 2, 2009 at 5:13 pm
(1) Paul says:

Six family members inherit realestate in New York State with current market value of $240,000. One member buys out other five for $5.00. What are tax consequences for family members?

July 28, 2009 at 10:06 am
(2) jennifer says:

What if the gift is not to a family member

July 29, 2009 at 3:52 pm
(3) William Perez says:

Whether the gift is to a family member or not does not make a difference in its tax treatment.

September 24, 2009 at 4:23 pm
(4) Nancy says:

Hmm. Okay I got the same some what problem. I live in a house that belong to my mother and now belongs to my father. We looked at quickclaim, inheritance, living will, now it’s foregiveness claim of 12,000 a year for 15years. what is this and what if he dies in 4 years? Is this the best way to take over a title deed to a property within a family? Noting that my father is still living and fine.

November 30, 2009 at 10:11 am
(5) James J. Coyne says:

I own a vacation home with a brother and two sisters and I want to gift them my portion of the property.We bought the house for 220,000 in 1995. How do I do this? Are there irs forms etc?

November 30, 2009 at 11:54 pm
(6) William Perez says:

James, you might need to file a gift tax form (Form 709) to report the value of the gift to your siblings. Since mot people are unfamiliar with this form, it may be advisable to consult with an experienced tax professional to review any questions or concerns you might have.

March 9, 2010 at 6:04 pm
(7) Candis Cary says:

In 1997 I inherited 50% undivided interest of my mother’s primary residence through her living trust. My brother inherited the other 50% and was also living in the home as his primary residence and taking the home deductions on his tax return at the time. The home was to be sold immediately but was not sold until 5 years later. By then the real estate value had increased so I did a 1031 Exchange on my 50% and purchased a vacation cabin putting title/ownership of cabin in my living trust. Current market value of cabin is now less than original purchase price. I want to gift the cabin to my adult daughter who uses it and maintains it and pays property tax on it. Can I gift to her out of my living trust now without either of us having to pay any type of tax? If my daughter decides to sell cabin in future would do as 1031 Exchange to buy a larger place. This would be a vacation home for her. She owns a condo as her primary residence. Thank you.

March 13, 2011 at 6:22 pm
(8) TEX says:

WHAT IS THE HOLDING PERIOD FOR DETERMINING LONG TERM OR SHORT TERM GAIN ON INHERITED PROPERTY?

March 14, 2011 at 4:33 pm
(9) William Perez says:

More than one year, or to phrase it differently, at least a year and a day. See this article for more about holding periods for capital gains.

April 14, 2011 at 12:24 pm
(10) Shannon says:

I was given a home as a gift, and it is my primary residence. I plan to sell it at the end of two years. The home was purchased for $320k, and is valued at $360k. If I sell it for $360k, would I pay taxes on the difference of $40k, or does the $40k become part of the $250k allowable, where you do not pay taxes? Would the $250k be an accumulated lifetime amount, or applicable each time? Also, if I put the entire $360k in a bank account, and not purchase another home, would the same rules apply? Would the bank send notification to the IRS that this amount has been deposited? Thank you!

February 18, 2012 at 2:40 am
(11) jack says:

http://www.irs.gov/publications/p17/ch13.html

Basis of Property

If you are not certain of the FMVs of the land and buildings, you can allocate the basis according to their assessed

values for real estate tax purposes. For exaxample if you were gifted property 10 years ago check county records for for assessed value of property at time of gift. Note if assessed at 1/3 value multiply by 3.

April 14, 2012 at 8:06 am
(12) junior gold miners etf gdxj says:

Excellent website. Lots of helpful information here. I am sending it to some friends ans also sharing in delicious. And of course, thanks for your sweat!

July 21, 2012 at 10:11 am
(13) Auction Goods says:

It’s actually a nice and helpful piece of info. I am glad that you shared this helpful info with us. Please keep us informed like this. Thanks for sharing.

July 29, 2012 at 1:17 pm
(14) gerald L. Bohlman says:

Question: My wife and I live in Ohio. We are thinking about passing our
home on to our children, prior to our deaths. What are the benefits in
doing this?

September 20, 2012 at 5:23 pm
(15) Bob Garg says:

I puchased a home 22 years ago for $175,000 today worth $475,000, if I gift the house to our son as he has been renting & living in it for the past 12 years.How is the Capital gain treated, if our son lives in the house, for two years , Can he get the $500,000 exclusion if he sells the home after 2 years, as the cost basis of $175,000 will be shifted to him. Please advise if gifting the house is the right thing to do..

July 23, 2013 at 1:05 am
(16) Douglas Moyer says:

I rec’d a piece of land to build a house on 13 years ago, from my father-in-law. At the time, it was verbally stated as a “gift”.
Now being in some financial difficulties, he wants paid for that piece of land.
Which I might add, he is asking for what he thinks he could have gotten 13 years ago for that land.
Please send me your thoughts

July 24, 2013 at 1:36 am
(17) William Perez says:

Douglas, you may want to consult with an attorney for advice. Strictly speaking, this isn’t a tax issue (just yet). The tax implications (if any) will be based on how this transaction is characterized.

August 1, 2013 at 9:51 pm
(18) jim says:

I own 33.3% of my moms home. She is still living in it, but plans move to an apt. If we sell what would the tn state and fed. Tac rated be on the sale…..

February 3, 2014 at 5:41 am
(19) Mr. Campbell says:

I want increase my real estaate value so please know me how i get it ?

February 20, 2014 at 2:11 pm
(20) Sergio says:

Hi William,
I have a rental home that I donated to a corporation.
The house has been a rental property for 10 years and it will continue to be a rental property. The only difference is the owner. I used to be the owner and now the corporation is the owner. I own the corporation 100%. I would like for you to tell me what forms do I need to file. Should I file form 8283 ?
Thank for your help!!!

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