Tips and Tricks for Today and Tomorrow #9: Don't Gift the House (Yet)
Gifting a family home to the next generation sounds generous, but it also transfers the original cost basis, which can create a large capital gains bill when the home is eventually sold. This video walks through a real-example comparison of gifting versus inheriting a $1 million home, including the IRS Section 121 exclusion and the step-up in basis, to show why timing can matter more than intentions.
Gifting a family home to the next generation sounds generous, but it also transfers the original cost basis, which can create a large capital gains bill when the home is eventually sold. This video walks through a real-example comparison of gifting versus inheriting a $1 million home, including the IRS Section 121 exclusion and the step-up in basis, to show why timing can matter more than intentions.
Key takeaways
- When you're gifted an asset like a house, you also inherit its original cost basis, which determines the capital gains tax owed when it's later sold.
- Under IRS Section 121, a married couple can exclude up to $500,000 of gain when they sell a primary residence they've lived in for two of the past five years.
- In one example, a home bought for $250,000 and now worth $1 million could trigger tax on $750,000 of gain if gifted, versus a much smaller taxable gain if the parents sell it themselves.
- Holding property until it passes through inheritance provides a step-up in basis to its value on the date of death, which can eliminate the capital gains tax that a lifetime gift would have created.
Today I want to talk about something I've seen come up a lot recently. Should parents gift their home to their children while they're still living in it, or plan to keep it long term? It's a generous idea, but it can create a significant and unexpected tax burden. Let's break it down.
In the past few months, I've spoken with multiple clients whose parents have suggested gifting their family home to them instead of selling it. The intention is good, but the tax implications can be huge. When you are gifted an asset like a house, stock, or car, you also inherit the original cost basis of that asset.
So, what is cost basis? Cost basis is the original purchase price. And when you sell the asset, the difference between the sale price and the cost basis is what you may owe capital gains tax on. Let's say your parents bought their home in 2000 for $250,000, and today that home is worth $1 million. If they sell it, they may only owe tax on $250,000 of gain. Why? Because under IRS Section 121, a married couple can exclude $500,000 of gain on the sale of a primary residence if they've lived there for two out of the past 5 years.
If they gift that home to you instead, you get the original cost basis of $250,000. So if you sell it for $1 million, you could owe capital gains tax on the entire $750,000 in gains. That's potentially over $100,000 additional in taxes just by changing who sells it.
Now, here's the alternative and why waiting might be a better option. If your parents hold on to the property and pass it on to you through inheritance, you receive a step-up in basis. That means your new cost basis becomes the market value at the date of their passing, $1 million in this example. So, if you sell the home for $1 million, you owe $0 in capital gains tax. That could mean a difference of $150,000 or more in family wealth preserved.
Now, of course, this isn't a one-size-fits-all decision. Your parents' tax bracket, their financial needs, and your financial situation all matter. But before anyone transfers title on a property, it's worth having a conversation about the full financial impact, because good intentions don't always equal good outcomes.
If you or your parents are thinking about gifting property, let's talk. We can weigh the options together and make the most tax-smart decision for your family. Thanks for watching.
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