Gifts or Sales? Differentiating and Documenting Property Transfers Within Family
Transferring property within a family is a common way to keep important real estate within the family and help younger generations build their wealth. However, it’s essential to understand the different ways you can transfer property to family members, as they have very different tax and legal implications. The way in which you transfer property could trigger a gift tax or put the receiving party on the hook for a capital gains tax. While selling or transferring property between family members can be fairly straightforward, discussing your options with a real estate attorney can help you better understand your options and the financial implications of your choice.
Transferring Ownership via Gift or Sale
The primary distinction between a gift and a sale of property lies in the exchange of consideration. The term “consideration” means something of value. In a sale, you are giving money in exchange for a piece of real estate; both parties receive something of value. On the other hand, a gift involves transferring ownership without receiving anything of value in return. While both methods can be used to transfer property within a family, they have different legal and tax consequences. Before tackling any property transfer on your own, it’s important to fully educate yourself on the potential financial consequences.
Tax Implications of a Gifted House
When a property is gifted, the recipient generally does not pay taxes on the gift’s value. However, the donor may have to file a gift tax return if the value of the home goes over their annual exclusion limit. As of 2024, the gift tax limit is $18,000. If the gift comes from a married couple, the limit is $36,000. Note that this does not mean you have to pay taxes on any gift above $18,000 or $36,000. It means that once you reach that limit, any value above that counts toward your lifetime gift tax. In 2024, the lifetime gift limit is $13.61 million per individual, or double that for married couples. So while the value of the home may tap into the $13.61 million limit, the donor doesn’t have to pay gift tax until they exceed that amount.
Another tax issue to think about is the capital gains tax. Assume that the family member bought the house in question for $300,000 and gave it to their younger family member. The younger family member then sells the house for $500,000 several years down the line. They would pay a capital gains tax on $200,000, the difference between the initial purchase price of the house and its market value at the time of sale. This can be a significant amount of money if the house has appreciated substantially.
Capital Gains Tax on Home Purchases
In contrast, when a property is sold, the seller may be subject to capital gains tax on any profit realized from the sale. In this case, the family member selling the house would be paying capital gains tax. The capital gains tax is calculated based on the difference between the property’s sale price and its adjusted tax basis. However, there are ways to limit or avoid capital gains taxes on a home sale. If the seller has used the home as their principal residence for two of the previous five years and the profit is $250,000 or less, you may avoid capital gains tax.
Taxes on Gifted vs. Inherited Properties
While we deal largely with sales vs. gifts in this particular post, it’s important to discern the difference between property given as a gift and property that is inherited. When family members inherit real estate, the cost basis for the recipient steps up to the market value on the decedent’s day of death. Again, we’ll use the example of a $300,000 house. At the time of the decedent’s death, the house is worth $450,000. If the recipient later sells the house for $500,000, their capital gains tax is based on the $50,000 difference, not the $200,000 difference.
Legal Implications
From a legal perspective, it is crucial that all property transfers between family members—whether those transfers happen by way of gift or sale—be properly documented and recorded. When family members transfer property, they often waive professional assistance to avoid extra costs. However, this can mean that crucial documents are missed or improperly filed. Consequently, the person receiving the property may have serious issues down the line if they have never actually legally owned the property in question. Working with real estate professionals ensures that all parties are protected throughout and after a transfer.
