Dear Liz: You recently wrote about the capital gains tax implications when someone sells a house they’ve been given, versus one they’ve inherited. Would you elaborate on the estate ramifications for the donor if that person has a large estate? Would their estate pay tax on the gift?
Answer: Few people have to worry about either gift or estate taxes, for reasons that will become obvious in a moment. But large gifts can potentially reduce the amount a wealthy donor can pass on to heirs tax free after death.
That’s because the gift and estate tax systems are combined. Gifts over the annual exclusion amount — which in 2023 is $17,000 per recipient — reduce the donor’s lifetime gift and estate tax exemption, which in 2023 is $12,920,000.
Let’s say a donor gives a $1-million house to a friend. The amount in excess of the $17,000 annual limit, or $983,000, is deducted from the donor’s lifetime limit. If the donor died in 2023, the amount of their estate in excess of $11,937,00 would be subject to estate taxes. (Donors only owe gift taxes after they give away so much that they exhaust that lifetime limit.)
Receiving assets as a gift also means the recipient may face more taxes than if they had inherited the property.
The previous column mentioned that when someone inherits a home, the house’s tax basis is “stepped up” to the current market value. That means the appreciation that occurred during the previous owner’s lifetime isn’t subject to tax.
If someone is given a house by a still-living donor, different rules apply. There’s no step up in value. The recipient gets the donor’s tax basis, which is typically what the donor paid for the home, plus any qualifying improvements.
When the house is sold, that basis is deducted from the proceeds to determine potentially taxable profit. The recipient could face capital gains taxes on the appreciation that happened since the original owner bought the house.
On the other hand, giving away assets during life is one way to control the size of a potentially taxable estate, says Los Angeles estate planning attorney Burton Mitchell. Once the house is given away, for example, its future appreciation won’t increase the donor’s estate.
Anyone with an estate large enough to worry about these taxes should, of course, consult an estate planning attorney about the best strategies for their situation.
This week’s top story: How to get paid for surviving the Southwest meltdown. In other news: Smart Money podcast on January money moves, and paying off your mortgage early, 4 ways to improve your odds of meeting new year’s money goals, and the path of mortgage rates prior to Fed meeting.