By Nathan Vinson, Attorney
English, Lucas, Priest and Owsley, LLP
Receiving a home or significant piece of property as a gift may sound wonderful. And it is, in nearly every case.
But sometimes when you get a piece of property as a gift, it’s not quite what you want, or perhaps it is too much of a burden to handle. You may decide to sell it, or, you may find it more advantageous to do an exchange. That’s a strategy we recommend to clients on occasion to help avoid tax on a second home. That tax is usually at the more advantageous capital gain rate, but nevertheless, it is still tax dollars out of your pocket.
I’ll explain how it works.
If you receive a piece of property as a gift, you generally have the same tax basis in the real estate as the person who gave it to you (depending on the value of the property at the time of the gift). So, if your mother buys a vacation beach house in Florida for $150,000, and gives it to you five years later, and you sell it for $300,000 fairly soon after, your tax basis in the property is $150,000. The IRS would tax the $150,000 you gained from the sale of the property.
If you received the beach house after your mother’s death (e.g. pursuant to your mother’s Will), your tax basis for the property would be the fair market value of the property at the time of your mother’s death. If it is worth $300,000 at the time of her death, and that’s how much the beach house fetches on the real estate market, then you don’t owe tax on the property.
In that case, it would be more advantageous from a tax perspective for your mother to leave you the property at death than gift it to you while she’s living. Sometimes, that is not the practical approach, however, as other circumstances dictate a lifetime gift of the property rather than upon her death. Also, if the property has declined in value since your mother purchased the property, a whole other handful of tax principals must be considered.
Generally, “loss property” should be gifted during someone’s lifetime rather than at someone’s death, because the property would take the lower fair market value basis at death. If the property subsequently appreciates in value, the gain will be taxable upon a sale of the property, even if the original cost of the property is not recovered.
However, losses on the sale of gifted property by a related party are limited. For instance, if your mother gifts you property that has declined in value since she bought it, you cannot turn around and sell the property and recognize the loss against other taxable income. Any decline in value after you receive the property as a gift may result in a tax loss to you, however. Note also, that unlike in the case of a deathbed gift of loss property, your sale of loss property that was given to you as a lifetime gift will not result in taxable gain unless the amount it sells for exceeds the original owner’s (e.g. your mother’s) basis at the time of her gift to you.
Exchanging the property means that you’re taking the property you were given – the Florida beach house that overlooks a parking lot – for another property you want – the Florida condo that overlooks the ocean. By doing the exchange, you delay the tax hit until you sell the property you received in the exchange. In tax parlance, this type of exchange is called a “like-kind exchange.” If you did not want to completely rid yourself of a Florida beach house, but rather just didn’t want the one given to you, a like-kind exchange can help you achieve that goal without running the risk of taking a tax hit. Also, the tax laws on like-kind exchanges are very favorable when it comes to exchanging real property. Almost any type of real property will qualify as eligible to be exchanged tax-free with another type of real property (e.g. a Florida beach house for an Iowa farm works – yes, it has happened).
With any of these situations, it’s best to talk to a tax professional. We can help you determine the most advantageous way for parties to handle succession of real property, both from a practical and tax point of view. We also recommend talking to an attorney in preparing to gift a property, either while you are living or in your estate. Good estate planning can save you, and those you love, a lot of headaches and keep more of your hard-earned money in your estate.
For more information, contact me, attorney Nathan Vinson, at firstname.lastname@example.org, or call me at (270) 781-6500.
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