When a Gift Comes With a Big Tax Price Tag


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6 Comments

Gift TaxWe received this question at USTaxAid. Got a question? Ask us at our website.

The question has to do with gift tax and gifting real estate. I’ll paraphrase the question below.

Q: My mom owns a condo, currently worth around $250k, which has a $0 basis after depreciation She has written it off as a rental on her taxes. She wants to give me the money the condo will sell for so that my husband and I may purchase our first house. Should she gift the condo to us and then we sell it? Should she sell it and gift us the money? Should she live in the condo for the next two years as her primary residence before gifting us the sale? Should she gift it to us and we live in it for the next two years before we try to sell it? Should we do a 1031 tax exchange in which she sells it and we both become partial owners of the next house? The latter is our least favorite as she doesn’t want to have to keep being on the title and transfer every time we decide to upgrade houses.

CondoA: When you’re selling real estate, there are generally two ways to pay less tax now. One is to take advantage of the capital gains home exclusion. The other is to use a like-kind, Section 1031 tax deferral. The problem with the like kind is that you get caught up in a treadmill of always need to buy another problem. You’re not getting away tax free, you’re just deferring the tax. Of course, there is a way out if the taxpayers are older. That’s by using a Charitable Remainder Trust. Of course, that’s really not practical in this case.

If the owner just sells the property, she’ll end up paying about 15% in capital gains tax. She also may have her social security income suddenly taxed, as her income goes up.

If she gifts the property to the daughter, it would just go at the basis. So she’s transferring the same issue to her daughter.

2The best answer, if possible, would be to have the mother move into the property and live there for 2 years. If she’s moving out of a house that she will need to sell, she needs to make sure it’s at least 2 years between the sales. This would allow her to get the capital gains home exclusion. That amount is $250,000 for a single taxpayer and $500,000 for a married couple. So, the mom would be right on the line of getting a tax free capital gain exclusion. If the property goes up in value during those 2 years, she’s either going to have to get married or pay some tax. (Paying tax would probably be the best answer. Shotgun tax marriages aren’t recommended.)

Another similar solution would be to have her gift the apartment to her daughter and then have her daughter live in the house for 2 years. She could then sell it and get the capital gains exclusion. Since her daughter is married, the gain exclusion would be $500,000.


6 Comments

  1. Diane Kennedy says:

    John, yes, there could be gift taxes due. I didn’t say it (and you reminded me) but you can file for a lifetime gift exclusion, which I would recommend in this case. Otherwise, gifts over the amount of $14K per person would be taxable.

  2. Diane Kennedy says:

    Tom, yes, if you sell the house and it’s not been your principal residence, you’ve got tax. One of the concerns I have, though, is the gift of the property. Did you file a lifetime gift exclusion on that? Otherwise, gifts over the amount of $14K can be taxable. Unfortunately, the IRS is right now scrutinizing deeds to see if people have skipped the exclusion filing…so suddenly there is tax due. If you’re in CA, you’re especially at risk. Talk to a tax professional if you think you might have an issue.

  3. Diane Kennedy says:

    You’re welcome, Kristen. I think it’s always better to go into a deal knowing the pros and cons, instead of being surprised. But, you’re right, not the best answer for you wanted to do. 🙁

  4. John B says:

    Hi Diane – just curious. Would there be a gift tax that the mother would have to pay (either by gifting the condo or the cash resulting from the sale)?

    If I follow your “best” situation correctly, Mom would owe no capital gains tax if she lived in it for 2 years. But then wouldn’t gift taxes be owed if the $250K was gifted to the daughter?

    John B

  5. Tom says:

    Diane,
    I am in a similar situtation. My mom has lived in her house close to 10 years. Last year she had the deed placed under my name. Next year on 2 years from when I assumed the deed, she plans to sell the home. The mortgage from the bank is still under her name. From what you said about the tax exclusion for homes sold under $250,000 would I have to pay anything since I do not live in the house?

    Tom

  6. Kristen says:

    Dear Diane Kennedy,
    Thank you so much for answering our question on your blog! While we don’t love the answer (we want to move now and not have to wait 2 years to sell), we are glad to finally have an answer to what seemed like a very complex problem that we can use to move forward with the gifting process. Your answer was very thorough and helpful! We really appreciate it!
    Kristen 🙂

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