A common question, and one where many taxpayers often make mistakes, is whether it is better to receive a home as a gift or as an inheritance. Generally, from a tax perspective, it is more advantageous to inherit a home rather than receive it as a gift before the owner’s death. This article will delve into the tax aspects of gifting a home, including gift tax implications, basis considerations for the recipient, and potential capital gains tax implications. Here are the key reasons why inheriting a home is often the better option.

Receiving a Home as a Gift

Let’s first explore the tax ramifications of receiving a home as a gift. Gifting a home is a generous act with significant implications for both the donor and the recipient, particularly regarding taxes. Most gifts of this nature occur between parents and children, making it essential to understand the tax consequences.

Gift Tax Implications

When a homeowner gifts their home, the primary tax consideration is the federal gift tax. The Internal Revenue Service (IRS) requires individuals to file a gift tax return if the gift exceeds the annual exclusion amount of $18,000 per recipient for 2024. This amount is adjusted for inflation annually. Since a home’s value typically exceeds this amount, filing a Form 709 gift tax return is often necessary.

While a gift tax return may be required, actual gift tax may not be due because of 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. For married couples, the $13.61 million exemption is doubled. The value of the home will count against this lifetime exemption.

Basis Considerations for the Recipient

The basis of the gifted property is a critical concept for the recipient. The recipient’s basis in the property is the same as the donor’s basis, known as “carryover” or “transferred” basis. For example, if a parent purchased 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 be $200,000. If the parent made $50,000 in improvements, the adjusted basis would be $250,000, which would be the child’s starting basis.

This carryover basis can significantly impact the recipient if they 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, the recipient could face a substantial capital gains tax bill.

Home Sale Exclusion

Homeowners who sell their homes may qualify for a $250,000 ($500,000 for married couples) home gain exclusion if they owned and used the residence for 2 of the prior 5 years. However, this gain qualification does not automatically pass on to the gift recipient. To qualify, the recipient must meet the 2 of the prior 5 years qualification. Thus, it may be tax-wise for the donor to sell the home, take the gain exclusion, and gift the cash proceeds.

Capital Gains Tax Implications

The capital gains tax implications for the recipient of a gifted home are directly tied to the property’s basis and the donor’s holding period. 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.

Special Considerations

Sometimes, a homeowner may transfer the title 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 death, potentially offering a step-up in basis and reducing capital gains tax implications.

Receiving a Home as an Inheritance

There are significant differences between receiving a property as a gift and as an inheritance.

Basis Adjustment

When you inherit a home, your basis in the property is generally “stepped up” to the FMV at the date of the decedent’s death. For example, if a home were 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 sold for $300,000, there would be no capital gains tax on the sale.

Long-Term Capital Gains

The holding period for inherited property is always long-term, meaning gains are taxed at more favorable long-term capital gains rates.

Depreciation Reset

The accumulated depreciation is reset for inherited property used for business or rental purposes, allowing the new owner to start depreciation afresh. This is not the case with gifted property, where the recipient takes over the giver’s depreciation schedule.

Conclusion

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. Considering the overall estate planning strategy and potential non-tax implications is crucial. Consulting with a tax professional can provide personalized advice based on specific circumstances.