Gifts are transfers of assets made before the original owner dies, not bequests, and the tax code distinguishes between the two. People occasionally receive real estate or other property as a gift...but they don't want it. They'd rather sell it and get the money. If they decide to sell, recipients of gifted property face different tax consequences than recipients of inherited property.
If you sell for less than the fair market value, you will lose money.
Even if the gift is cash, the Internal Revenue Service (IRS) does not consider it income. You can receive a million dollars from your wealthy grandmother and not owe the IRS a dime. If your grandmother gives you a non-cash gift, you will not owe the IRS a gift tax. You will only have to pay this tax if you give the gift away or sell it for significantly less than its fair market value.
Annual Exemption and Lifetime Exemption
In tax year 2021, you could give away up to $15,000 in cash or property to anyone without incurring gift tax. For 2022, the limit has been raised to $16,000 USD. You have two options if you want to give more than that per person per year:
It is possible to "charge" it to your lifetime exemption.
For tax year 2021, the lifetime exemption is $11.70 million, and for tax year 2022, it is $12.06 million. The exemption is gradually reduced for each gift made in excess of $15,000 per person per year in 2021 ($16,000 in 2022). If your estate's value is equal to or less than the remaining lifetime exemption, anything left over would shield your estate from paying the estate tax when you die.
A Gift Tax Exemplification
Assume your grandmother is a famous artist and she gives you a $1 million painting. You flip it and sell it for $500,000. Because your grandmother's artwork was valued at $1 million, the IRS considers you to have made a $500,000 gift to the buyer. That's $485,000 more than your annual $15,000 exclusion, so you'd have to either pay gift tax on the difference or deduct it from your $11.70 million lifetime exemption in 2021.
The Cost Basis of Gifted Property for Capital Gains
What if you decide to sell the gift instead at fair market value? You must report any capital gain or loss, and if you make a profit, you may be required to pay capital gains tax.
The cost basis in the asset of the original owner is used to calculate capital gains or losses on gifted property received during the donor's lifetime. However, if you were to inherit the property instead, its cost basis would be "stepped up" to what it was worth on the date of their death—that is, if the original owner decided to wait until their death to pass it on to you.
This can make a significant difference. The gift basis is the amount paid for the property by the original owner, plus or minus any adjustments. Significant repairs and improvements, as well as any expenses incurred in the sale, such as broker's commissions, are examples of adjustments that increase basis.
Depreciation that the previous owner may have claimed for renting out the property is a common adjustment that reduces basis. This depreciation is also passed on to the new owner. The sale price minus this adjusted cost basis would be the recipient's gain or loss on the gift.
A Cost Basis Before Death Example
Assume your parent transfers their $300,000 home to you before they die. They paid $80,000 for it 30 years ago and have spent $40,000 on improvements over the years. They never claimed any property depreciation. As a result, your cost basis is $120,000 ($80,000 plus $40,000). If you sold the house for $300,000, you would have made a $180,000 capital gain.
An Example of a Cost Basis Following Death
Assume your parent transfers ownership of their home to you as part of their estate plan after death. Because of the increase in basis, the situation is vastly different. If the property's fair market value is $300,000 as of the date of death and you sell it for $300,000, there is no capital gain to be taxed. In either case, you get $300,000, but in the second case, you don't have to give any of it to the IRS.
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