Do you want to know if you can gift real estate tax-free? I can tell you for free based on my experience.
First and foremost, giving someone the gift of real estate can be an excellent way to express your affection while keeping a house in the family.
However, donating property might have tax consequences, such as the federal gift tax.
If your parents, grandparents, or anybody else want to give you a house as a present, they must file a gift tax return form and pay any necessary taxes.
Gift taxes on real estate can be confusing and costly, but I am here to educate you on everything you need to know about the gift tax on real estate and how you may be able to avoid it.
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Now, let’s get started.
What Is The Real Estate Gift Tax
The Internal Revenue Service (IRS) charges homeowners a type of gift tax whenever a property is given to someone else for nothing or less than the total market value.
All U.S. citizens and residents who make gifts totaling more than $17,000 in a calendar year must submit the gift tax form, often known as Form 709.
The IRS gift tax is not intended to discourage people from making presents to others.
Instead, it exists to assist the government in preventing people from avoiding paying taxes when transferring money.
For example, if you give property to someone during your lifetime, you must pay gift tax.
Gifted property is taxed under the law, although the IRS has set a lifetime gift and estate tax exemption of $12.92 million per individual for the 2023 tax year.
That implies you may donate up to $12.92 million in gifts to others without paying taxes on them.
Remember that this number covers what you donate while alive and leave behind after death.
However, because the IRS does not intend to tax every dollar you donate to someone else, only significant donations (those worth more than $17,000 in 2023) count against the $12.92 million exemption limit.
How Does Gift Tax Relate To Estate Tax
You are eligible for a federal estate tax exemption of $12.92 million for 2023. You are exempt from paying any federal estate tax on gifts of up to that amount made to family or friends.
If you are married, your spouse is eligible for a $12.92 million exemption in addition to your own.
Your taxable estate can be reduced by making gifts throughout your lifetime. This is accomplished by transferring assets out of your ownership and, as a result, outside of your estate.
However, your estate tax exemption will be reduced if you make donations greater than the yearly exclusion amount.
1. Using the previous instances, if you made two taxable gifts totaling $21,000 in 2023, your estate tax exemption would be reduced by $8,000, bringing it down to $12,912,000 ($12,920,000 minus $8,000).
2. Your estate tax exemption will not be lowered due to the individual donation of $10,000 in 2023 or the three contributions totaling $17,000 in 2023.
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What Happened When Real Estate Is Given As A Gift Freely
If the property were given to you as a gift while the donor was still alive, your cost basis would be the same as the donor’s because there is no step-up basis.
If the property was given to you and acquired by the donor for $100,000, then your cost basis is still $100,000, even though it is now worth $350,000.
Note:
Examine your “adjusted cost basis” in the property because your cost basis may have been decreased even more by any depreciation the donor could have claimed or claimed as a tax benefit over the years.
To reiterate, the smaller your base is, the larger the gain you would realize if you decide to sell the property.
What To Do If You’ve Been Given Real Estate
If you’ve previously received real estate as a gift, you have a few options:
1. You are free to retain the present. You’ll have to pay taxes if you sell the property, but your heirs’ basis will increase if you keep it until you die.
They can then sell it and avoid paying capital gains taxes.
2. You can return the property. The donor’s cost basis is the same as yours, which means their initial cost basis is adjusted for depreciation. They may then leave the property to you as an inheritance instead.
Finally, you can transfer the property to someone like your kid or a relative.
Choose someone who will not be taxed on capital gains based on their income if they sell.
Alternatively, you might donate it to a charity, which would get all the profits tax-free and provide you with an itemized tax deduction, subject to certain limitations.
Do Real Estate Gift-Free Taxes Affect Saving?
Because the estate tax is levied on asset transfers, it effectively taxes people’s savings.
The amount of estate tax people pay varies depending on what they do with their money, even among persons with equal wealth.
For example, the inheritance tax on someone who saves more will be greater than the estate tax on someone who spends more.
As a result, by making it more challenging to leave money to heirs, the estate tax may encourage people to save and invest less.
However, the empirical data on the estate tax’s effect on keeping is equivocal.
Several factors contribute to the need for more agreement on the overall effect of the estate tax on saving.
Because of the estate tax, fewer inheritances handed to heirs may encourage persons or their heirs to save more.
On the other hand, estate taxes would have little impact on the saving behavior of persons who do not expect to leave a legacy.
Another factor to consider is how capital gains taxes are applied to the value of inherited assets.
Because of the step up in basis, an asset’s cost basis is increased to its fair market value upon inheritance.
Any rise in value while the decedent possessed the item is not subject to capital gains taxes, which may encourage people to save more.
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How To Reduce Your Real Estate Taxes With Gifts
One of the purposes of an estate plan is to minimize taxes and enhance your heirs’ legacy.
Lifetime giving can be an efficient strategy that provides significant tax savings.
Gifts are only sometimes appropriate, but it is vital to understand the restrictions and evaluate the benefits they may provide as part of your legacy plan.
1. You have a $5,490,000 lifetime gift tax exemption.
You can make total lifetime contributions of up to $5,490,000 without incurring any federal gift tax (though a state gift tax may apply if you are a Connecticut citizen or make a gift of Connecticut real estate).
However, spending all or part of this exemption during your lifetime will reduce your federal estate tax exemption after death.
2. You can give up to $14,000 to as many individuals as you wish each year without paying a federal gift tax or utilizing any lifetime gift exemptions.
Because this limit is per person yearly, married couples can give $28,000 to as many people as they wish as long as each spouse contributes $14,000.
This excludes presents made in direct payment of another person’s tuition or medical expenditures, which are tax-free and do not qualify for the gift tax exemption.
For example, you can give your grandchild a gift of $14,000 without using any of your lifetime gift deductions. You can pay for their education directly, even if it costs over $14,000.
3. Gifts that use exemptions can save taxes even if the exemption is depleted at death.
Gifts that take advantage of gift tax exemptions lower the amount that can be shielded from estate taxes upon death.
However, if the gift tax exemption is correctly leveraged, utilizing exemptions throughout your lifetime can considerably minimize estate taxes owed upon your death.
Suppose you give away an income-generating or appreciating asset.
In that case, you essentially give away the future income or appreciation without any exemption or that portion of the gift.
Still, if you keep the item until your death, it’s worth and the value of your estate would be more significant.
4. It might sometimes be advantageous to make a gift even if it results in a tax liability.
Making a taxable gift more significant than your exemption and resulting in a needed gift tax might still be a good idea for people with very large estates since any future income and value gains from the moved property would not be subject to transfer taxes when the person dies.
Furthermore, because the gift tax is paid during your lifetime, it acts as a credit for estate tax purposes.
This method has some problems, so it’s important to talk to an expert estate planning lawyer about the pros and cons before making any gifts that could lead to tax problems.
5. Think carefully about the property you intend to give as a gift.
There are both personal and tax motivations for choosing which property to donate. Insurance plans, for example, may make excellent gifts.
Typically, the donor does not require the cash worth of the insurance policy to live on throughout their lifetime; thus, there is little hesitation in giving it away.
At the same time, because the death benefits from the income are not taxable in the estate, it can give large tax savings to the estate and recipient.
When deciding which property to donate, consider if it is likely to appreciate at a high rate of return, whether it has a low tax cost basis, and when is the optimum time to make the gift from a value aspect.
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Final Thought
Now that we have established that you can gift real estate tax-free, you may have heard that you should withdraw an asset from your living trust before donating.
For example, if you wanted to give your son a $5,000 cash present and your bank account is in your trust’s name, you would write the check payable to yourself, cash it, and then make the gift in cash or use a cashier’s check.
This is because, in the past, if you died within three years of donating directly from your living trust, the IRS would have attempted to include the gift.
Even if it was an annual tax-free gift in your taxable estate.
But you no longer have to play this shell game.
Gifts from a revocable living trust are treated the same as those made now from you, even if made within three years of death.