Gifting a house to a relative will affect your income tax and real estate property tax. Know the consequences of gifting vs. inheriting.
Q: I thought you might have said on your radio show that you didn’t advise giving a home away. My uncle is thinking of giving me an old house, but I didn’t remember why that was a wrong thing to do. Please can you tell me again, so we don’t make a mistake?
Gifting a House to a Relative
A: If someone wants to give you an old house, or a new house, you should probably say yes. But, I want you to understand how being given a house will affect the federal income taxes you may pay at some point in time on the property.
The questions people face is whether to give a house to their children (or, in this case, niece), or allow them to inherit it after they die. When you give a house, you give the property at its current cost basis. The cost basis is the amount the owner paid for the property plus the costs of purchase, if any, and the cost of any capital improvements that were made along the way. Capital improvements would include replacing the roof, the mechanical systems or the cost of building a new addition. It would not include repainting or redecorating a living room.
Once you understand the cost basis for the home, that would become your cost basis if your uncle gifted you the home. The tax implication comes from the difference between the cost basis and the price you ultimately sell for down the road.
For example, if the cost basis of the property is $50,000 and you sell the home ten years from now for $300,000, you would show a profit of around $250,000. If the home is your primary residence, and you can still exclude up to $250,000 in profits (up to $500,000 if you’re married on a primary residence), then you would owe nothing in taxes. Let’s say instead that the property is a rental and you have $250,000 in profits. Then you’d owe long-term capital gains tax on the profits plus you’d have to recapture any depreciation you claimed along the way.
If you inherit the property from your uncle, you would inherit it at the current market value, which let’s say is $150,000 today. In ten years, the property might be worth $300,000, but your profit would only be $150,000. If you had the property rented, you’d owe tax on $150,000 instead of $250,000, plus depreciation. So you can see why inheriting property would be better than having it gifted to you.
There’s another tax issue for the gifter. If you’re given a house for $50,000, that’s above the annual gift exclusion limit, which is $13,000 for 2012 and $14,000 for 2013. So the gifter might have to file a gift tax form with the IRS and have the amount over the $13,000 deducted from the one-time gift exclusion.
The IRS has good information on the gift tax and how it works here. You should also download Publication 950 Introduction to Estate and Gift Tax to understand further how this might affect you or your uncle.
Does the Home Have a Mortgage?
An additional issue for you to consider is whether the home has debt on it or not. If your uncle borrowed money to buy the home and the home has a mortgage on it, you need to know that the mortgage will not go away if your uncle gifts you the home. You or your uncle will still need to make payments on that debt. In any case, due to the transfer of title in the home to your name, the lender may have the right to call the loan in – that is to say, the lender can say that the balance owed on the whole mortgage must be repaid immediately. If you don’t repay the debt, the lender can foreclose on the home and sell the home to satisfy the debt.
Potential for Reassessment
One last item to consider, when you take title to the home, you need to know that in some states, the local taxing body may reassess the value of the home and you may have to pay real estate property taxes at a much higher rate that before. For example, we have relatives in Florida that have lived in their home for thirty years or so and their real estate property taxes are quite low. They know if they sell their home, the new buyer’s real estate taxes will skyrocket.
The bottom line is that getting a house for free is never a bad idea. We just want you to understand what the consequences are of the transfer and what tax implications might be down the line, so you’re prepared when it comes time to sell and move on.