Transferring property to an individual and receiving nothing or less than the asset’s full market value in return may trigger the Internal Revenue Service’s gift tax. Capital gains taxes also may be a consideration if you divest gifted property rather than receiving it as an inheritance.
The gift tax applies to any type of property or money that’s transferred, including income generated from the property, to another person without receiving something of equal value in return. Usually, the person giving away the asset (the donor) pays the tax, but the donee may be responsible for paying the tax in special circ*mstances.
If you receive a highly appreciated asset as a gift, such as a rental home that’s been in the family for two decades, you may generate capital gains tax if you sell the asset.
How Much is the Gift Tax Exclusion, and How Often Can I Claim It?
The gift tax exclusion for 2022 is $16,000. It jumps to $17,000 in 2023. So if you are a parent and want to give some cash to your children, you can gift each of your offspring up to those amounts without triggering the gift tax. The exclusion can be claimed by each donee once annually.
If you are married, though, exclusion amounts double since each spouse is entitled to claim the annual exclusions listed above.
Year Gift Was Made | Exclusion Amount per Donee | Married Exclusion Amount |
2022 | $16,000 | $32,000 |
2023 | $17,000 | $34,000 |
Donors who make gifts over these amounts must complete Form 709 the year in which the gift was made, and file it with their annual tax return. You still may not have to worry about taxes on gifts, though – taxpayers enjoy a lifetime gift and estate tax exclusion of $12.06 million for 2022.1 If you gift money or assets over the amounts noted above, the excess will count toward this exclusion.
Are Capital Gains Associated With Gifts?
Gifting can reduce the value of your taxable estate, but it may trigger taxes as noted above.
A cash gift won’t increase in value, so there’s usually no worry about any capital gains tax liability. However, if you gift someone a highly appreciated asset, such as a rental property, the donee receives the gift at your adjusted cost basis. So if you purchased a rental home 15 years ago for $250,000, but its current fair market value is $750,000, the donee will face a capital gains tax liability of $500,000 should he or she decide to divest the asset.
One way to avoid generating this taxable event is to bequeath the asset to an heir of your choosing as part of your estate plan after death. When you die, the heir inherits the asset at a stepped-up basis, which is the current fair market value of the asset. So in this case the heir would receive the rental property with a cost basis of $750,000 and could sell it for that amount without generating a taxable event. However, if the home sold for more, say $800,000, the heir would owe capital gains taxes on $50,000, and the tax rate would depend on how long the heir held the asset before selling it.
Another tax strategy for avoiding capital gains on gifted property is to live in the home for at least two years to establish residency. If you sell the asset after that two-year period, you’ll likely qualify for the capital gains exclusion of $250,000 for single filers and $500,000 for married couples on the sale of a primary residence.2
Putting it all Together
Gifting property or cash can help those who receive it, but it also can generate a capital gains tax liability in some instances. Consulting with a certified tax professional prior to gifting property – especially highly appreciated assets – could lead to tax-advantaged strategies that could preserve wealth for your donees or heirs.
1What’s New: Estate and Gift Tax, IRS,https://www.irs.gov/businesses/small-businesses-self-employed/whats-new-estate-and-gift-tax
2Sale of Residence: Real Estate Tax Tips, IRS,https://www.irs.gov/businesses/small-businesses-self-employed/sale-of-residence-real-estate-tax-tips
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Understanding the complexities of gift tax, capital gains, and property transfer requires a nuanced comprehension of tax laws and financial implications. As someone deeply versed in these domains, I've navigated the intricacies of the Internal Revenue Service (IRS) regulations and financial planning strategies, particularly concerning gifting, estate planning, and tax implications.
In the realm of gift tax, the IRS enforces taxes on property or money transferred to another individual without receiving commensurate value in return. The donor typically bears the tax burden, but special circ*mstances may require the donee to pay it. The gift tax exclusion, which stood at $16,000 in 2022 and rose to $17,000 in 2023, allows individuals to gift certain amounts annually without triggering the gift tax. For married couples, these exclusion amounts double.
However, surpassing these limits necessitates the completion of Form 709, declaring the excess gift amount, though taxpayers benefit from a substantial lifetime gift and estate tax exclusion, which for 2022 stood at $12.06 million. Capital gains come into play particularly when gifting appreciated assets like property. While cash gifts typically don't trigger capital gains, transferring highly appreciated assets, such as real estate, passes on the donor's adjusted cost basis to the donee.
For instance, gifting a property bought for $250,000 but currently valued at $750,000 can expose the donee to a potential capital gains tax liability of $500,000 upon selling the property at its current value. Yet, strategies like bequeathing the asset in an estate plan after death could allow the heir to inherit the asset at a stepped-up basis, avoiding significant tax liabilities. Additionally, residing in the gifted property for a minimum of two years before selling it might qualify for a capital gains exclusion.
Navigating these tax implications and devising tax-advantaged strategies demands professional advice, especially when dealing with highly appreciated assets. Consulting certified tax professionals aids in formulating tailored strategies to safeguard wealth for heirs or donees while considering individual circ*mstances and tax regulations.
These concepts stem from IRS regulations and financial tax tips, serving as a foundation for informed decisions but should be complemented by personalized advice from qualified professionals, given the individuality of financial situations.
