Want to learn what it means to have no good deed go unpunished? Try giving your house to a family member.
Why? Because Uncle Sam will try to squeeze every last bit of value out of your generosity.
Which means the legal question of how to deed a property to your children quickly becomes a tax question about how to minimize gift taxes, capital gains taxes, and estate taxes. This is one case where it quite literally pays to be prepared.
Fortunately, it’s possible to transfer property to your loved ones in a tax-efficient manner. Keep reading to learn your options, and don’t be afraid to talk to an estate planning attorney if you still have questions.
How to Gift a House to a Family Member
You can transfer legal ownership of a home to your children in several ways. The most common options include leaving it to them in your estate plan, giving it to them immediately, and putting it in an irrevocable trust.
1. Leave It to Them in Your Will
One easy way to pass property to your heirs is simply by leaving it to them in your will.
You name the beneficiary in your will, and you can stop worrying about it. When you kick the bucket, the property goes into probate along with all your other assets, to be distributed based on your wishes.
You avoid paying capital gains taxes because you never sell the property. In fact, nobody pays capital gains taxes on it, because when you die owning an asset, the cost basis resets to whatever it’s worth at your death. So there is no capital gain at all, from the perspective of the IRS.
Your children may still run afoul of federal estate taxes, but only if your estate exceeds the $12.06 million exemption in 2022. Beware that some states charge their own estate taxes, and may take a bite out of your children’s inheritance.
The probate process does add time and expense to the transfer of assets. And because mortgages aren’t typically assumable, your heirs will need to pay off the balance during the probate process. That could mean refinancing or paying off the balance from other estate assets, or selling the property.
2. Put the Property in a Revocable Trust
Probate comes with some costs for your heirs. On the low end, expect it to cost 1 to 2% of your estate, and costs can run as high as 7% for more complex or contested estates.
You can avoid probate by putting your assets into a living trust, rather than assigning beneficiaries through your will. Living trusts are revocable, meaning you can make changes at any time. And for large, complex assets such as real estate, it can make the ownership transfer far faster and easier for your heirs.
If you still want to use the property between now and when you shuffle off this mortal coil, consider leaving it in your heirs as part of your estate — whether through a will or living trust — and not hassling any further.
3. Gift It to Them Today
Or not — you could deed the property over to them right now.
You don’t have a capital gain, since you didn’t sell the property for a profit, so you don’t owe capital gains taxes. The IRS still wants their pound of flesh though, so they hold you liable for gift taxes.
Even so, giving your properties away can work well as a low-tax real estate exit strategy. More on how gift taxes work shortly.
4. Put It in an Irrevocable Trust
Alternatively, you can give real estate to a loved one through an irrevocable trust.
You create the trust as a legal entity, set up rules for it, name a trustee to manage it and beneficiaries to collect on it, and transfer legal ownership of your property to the trust. At that point, you no longer own it and can’t change the rules.
On the plus side, it protects the house from creditors coming after you personally. The house also becomes exempt from estate taxes, as you no longer own it and it doesn’t become part of your estate when you die.
But trusts have to file their own tax returns and sometimes pay higher taxes than the individuals associated with them. Speak with an estate planning attorney before going too deep down this rabbit hole.
5. Add Them to the Deed as a Joint Owner
You could always add your children to the deed as another owner of the property. When you exit stage left, all surviving owners inherit your share equally.
But adding them as another owner comes with its own wrinkles. First, the ownership portion you gave away counts as a gift and is subject to gift tax.
Second, your recipient inherits your cost basis, rather than having it wiped clean when you die. They pay capital gains tax based on your original purchase price.
And, of course, you no longer have total control over the property. Your family members suddenly get equal rights to use the house however they like. They can even vote to sell it. If one owner becomes incapacitated, it can be difficult for the surviving owners to sell the property if they so choose.
In many cases, it’s easier to simply leave the property in your will rather than adding your kids as owners while you’re still alive.
6. Sell Them Your Home
Another option involves selling the home to your children. You could sell it below market value, or perhaps sell it at market value with seller financing.
While it sounds complicated, seller financing doesn’t have to be. You can find or buy a promissory note at websites like Law Depot and create an amortization schedule instantly through free online tools like MortgageCalculator.org.
However, if you sell your home to your kids at a discount, the IRS considers the difference between full market value and the sales price to be a gift. For example, you own a property worth $250,000, and sell it to your grown son for $150,000. Uncle Sam counts the $100,000 discount as a taxable gift.
Instead, you could sell it for $250,000, with a $250,000 seller-held mortgage. Your son then owes you monthly payments, by law you must charge at least the Applicable Federal Rate for interest, published each month by the IRS. Uncle Sam adds insult to injury by forcing you to declare the interest and pay income taxes on it each year too.
Technically, if you forgive the debt — whether while you’re alive or after you die — it becomes a taxable gift. But if your son defaults on those payments, no one says you have to foreclose on him. For that matter, no one says you have to record a lien against the property at all. You do need to sign a note with him however, proving the loan’s existence.
If you have an existing mortgage on the property, you’ll almost certainly need to pay it off when you sell the property to your child. Mortgage loans come with a “due on sale” clause, requiring full payoff when ownership changes.
7. Buy a House to Gift to Them
Rather than giving (or leaving) cash to your child, you could buy a property and give or leave that to them instead.
But given how expensive closing costs are, both upon buying and selling, you should have a good reason to give them a specific property rather than just giving them cash. It’s easier and more efficient to just write them a check or leave money in your will.
Tax Implications of Gifting a Home to a Family Member
As a quick primer on gift taxes, you can give up to $16,000 per year to each recipient in 2022, tax-free. That limit applies individually, so married couples can give up to $32,000 per year to each of their adult children with no gift taxes. And if your child is married, you can also give to their spouse tax-free. So, married parents could give up to $64,000 tax-free each year to their married child and spouse.
If you exceed the annual gift limit, you have to file IRS Form 709. That doesn’t mean you owe gift taxes this year however — the IRS counts the overage toward your unified lifetime gift and estate tax exemption of $12.06 million in 2022.
If this number sounds familiar, that’s because it’s the combined limit for both tax-free gifts and inheritance. For instance, if you give your child $6 million while you’re alive, and leave them $6.2 million in your estate, they’ll owe federal estate taxes on $140,000 ($0.14 million). Likewise, if you give your child $12.2 million over the course of your lifetime, you start owing gift taxes after crossing the $12.06 million lifetime limit.
Real estate gifts count toward both the annual and the lifetime limits. But only the equity: if you own a property worth $200,000 with a $150,000 mortgage, the $50,000 in equity counts as the gifted amount. So, you’d subtract the $16,000 annual gift tax exclusion, and the taxable gift would be $34,000.
However, when you give property while still alive, your child inherits your cost basis. That means they owe capital gains based on what you paid for the property, when they go to sell.
Imagine you buy a property for $100,000, own it for a little while, then give it to your child. Years later, they sell the property for $300,000. They then owe $200,000 in capital gains tax on the property sale — capital gains taxes they wouldn’t owe if you had left the property to them in your estate.
How to Avoid or Minimize Taxes When Gifting a House
As outlined above, the cost basis for real estate “steps up” to its fair market value at the time of your death, when any property in your estate officially transfers to your heirs. If your heirs sell the property within 6 to 12 months as part of the probate process, the IRS typically accepts the sales price as fair market value at the time of death. Your heirs pay no capital gains tax.
Equity in the property still counts toward your estate however. If your estate exceeds the federal exemption amount — $12.06 million in 2022 — your heirs may owe inheritance taxes.
If you worry about exceeding the exemption, consider spreading your children’s inheritance out over the years. It might make sense to give your kids $16,000 in cash each year while leaving assets like real estate and stocks as part of your estate. That way, the cost basis steps up upon your death. Consider using an irrevocable trust if you worry about exceeding the estate tax exemption.
Alternatively, you could sell a property to your children at fair market value, with a seller-held mortgage. You could then forgive up to $16,000 of mortgage debt each year, as your tax-free gift.
And if you just happen to underestimate how much “fair market value” means when selling the house, well, property prices are subjective. Just be prepared to defend your sales price with comps, needed repairs, or ideally an appraisal if you get audited.
You’ll pay taxes on capital gains when you sell the property to your children. But bear in mind that you can avoid up to $500,000 in capital gains tax when you sell your primary residence. If your kids live in the property for a while before selling, they can take the primary residence exclusion too.
FAQs on Gifting a House to a Family Member
If your head is spinning with all these different types of taxes and exemptions, you’re not alone. This is why estate planning attorneys make the big bucks.
Here are a few common questions to help you wrap your head around the various tax types.
Should You Gift Property to a Family Member?
You should only gift real estate to family members while you’re still alive for practical reasons.
For example, if you plan to move into a retirement home at some point in the future and your daughter wants to move into your home after you vacate it, it might make sense to gift the property to her now.
However, the equity portion of this gift counts toward your unified estate and gift tax exemption. Additionally, your original cost basis carries over to your daughter. When she sells, she’ll owe capital gains tax on the difference between the sales price and your original purchase price.
She’d probably be better off moving in and paying you some nominal rent while you’re still alive without yet taking ownership of the property. She’ll inherit the property upon your death anyway. Just beware that if your family member doesn’t pay you “fair market rent,” the IRS may not let you classify it as a rental property, and you lose valuable tax advantages.
Can You Transfer Your Home With a Mortgage?
Most lenders don’t allow you to transfer ownership without paying off the mortgage.
A small minority of loans are assumable, which means a new owner can step in as the borrower. But even then, they have to go through a rigorous application process with the lender, who might just say no.
You could record a gift deed or quitclaim deed that transfers your ownership to your child. But if the lender finds out, they can call your loan. You remain personally liable for the balance, and the lender could foreclose if you fail to pay off the loan immediately.
Does a Quitclaim Deed Qualify as a Gift?
In a word, yes.
Whether you use a gift deed or a quitclaim deed with no consideration (payment), it counts as a gift in the eyes of the IRS. To qualify as a normal real estate transaction, you must sell your ownership interest for fair market value — or close enough to it that you can defend against an IRS audit.
Can I Gift My Home to Someone While I’m Still Living There?
Yes, but it gets complicated.
If you fail to sell the house for fair market value, the IRS would tax the difference as a gift. If you then fail to pay fair market rent to your family member, the IRS could classify your home as part of your taxable estate after you die, claiming that you never completely gave up “possession and enjoyment” of the home.
As an alternative, you could create a qualified personal residence trust (QPRT). But that also gets complicated quickly, involving an irrevocable trust, complex IRS calculations based on the present value of your beneficiaries’ right to receive the property at the end of the trust term, and other legal maneuvers sure to make your head hurt. Before setting up a QPRT, have a long chat with an estate planning or tax attorney to make sure it’s right for you.
What Are the Alternatives to Gifting Real Estate?
You can always leave your property to your heirs as part of your estate.
If you want to transfer ownership to them sooner, consider selling it to them for fair market value — or close enough to it that the IRS won’t come after you — and financing it with a seller mortgage.
You can then proceed to make tax-free gifts to your heirs each year thereafter. These gifts help subsidize their loan payments or directly forgive the balance $16,000 at a time.
Beware that if you just add them to the deed, they take on your cost basis. That could result in a nasty capital gains tax when they go to sell.
When you transfer real estate to a family member, you have to worry about gift taxes, estate taxes, and capital gains taxes.
But if you don’t expect your total lifetime (and post-departure) gifts to exceed the $12.06 million limit, gift taxes and estate taxes don’t apply. That frees you to focus on just minimizing capital gains taxes, for both you and your heirs.
Consider “Plan A” to be leaving your real estate behind in your will, rather than giving it away while you’re still kicking. If you’d rather give away a property now, speak with a tax attorney about the best way to do it. Otherwise you may find yourself or your heirs lining Uncle Sam’s pockets more than necessary.