The Tax Implications of Selling Gift Property
Figuring out Capital Gains when Selling Property You Received as a Gift
People sometimes end up owning real estate and other property because the original owner has given that property to them. Transfers of property given before the original owner dies are gifts, and recipients of gift property have different tax consequences than recipients of inherited property.
The Basics: How Gifts Interact With Taxes
This is one of those taxes that doesn't work quite the way you might think.
Normally, when someone receives money or property, either through earned income or by another means, the Internal Revenue Service wants its share. It's the opposite with the gift tax. The recipient does not pay any taxes or report any income when the gift property is received – instead, the donor the property must report the gift and pay possibly pay a gift tax subject to certain available exemptions.
But what happens if you decide not to keep the gift? What if you sell it? Now you must report the gain or loss and possibly pay capital gains tax if you realize a gain.
How Capital Gains Are Calculated on Gift Property
Capital gains or losses on property received as a gift are calculated according to the original owner's cost basis in the property. In other words, the recipient receives both the property and the property's cost basis when the property is gifted. The recipient also receives the donor's holding period in the property for determining whether a gain is long term or short term.
The basis of gift property is the original owner's cost basis plus or minus any adjustments. Typical adjustments that increase basis are substantial repairs and improvements, along with any expenses for selling the property, such as broker's commissions. Typical adjustments that reduce basis are depreciation that the previous owner might have claimed for renting out the property.
The recipient's gain or loss on the gift property will be the selling price minus this adjusted cost basis.
Recordkeeping Tips for Gift Property
Ask the donor to provide you with the cost basis of the property and to let you know the date he or she originally purchased the property. Try to obtain a copy of an escrow statement to document the amount and date of the purchase.
You'll also want to get an estimate of the fair market value of the property on the date of the gift transfer because sometimes the market value comes into play with gain or loss calculation. This can be as simple as arranging for an appraisal.
Tax Strategies for Gift Property
If you received real property as a gift, consider living in the property for at least two years before selling it. This will make you eligible for a capital gains exclusion of up to $250,000 on the sale of a primary residence if you're single, and double that amount if you're married and file a joint return.
If the property is being rented out, consider a Section 1031 exchange to defer the tax.
Consider giving the property to someone else. This would transfer the tax liability to the new owner. Charities can sell properties without paying any capital gains tax and you would receive a tax deduction for the fair market value of the property as a charitable donation.