Think Twice Before Accepting Your Parents’ Home as a Gift

Your parents could have many reasons for wanting to gift you their home or another property while they’re still alive. Maybe it’s so you can move in with your young and growing family or so you can own your first investment.

Now this isn’t for every case, but I tell my clients that it’s almost always better to inherit a home or property rather than receive it as a gift. Why? The number one reason for most of us: taxes.

Example:

Let’s say your parents purchased their home for $200k and it’s now worth $1 million (a believable story in Los Angeles). To keep the example simple, we’ll assume no work was done to the home and that the cost basis is an even $200k. That means, there’s an unrealized capital gain of $800k.

The Big Problem for You:

When you receive your parents’ property as a gift, you retain their cost basis. Meaning, if your parents paid $200k, the IRS now views it as if you paid $200k for the property (not the current $1 million). So, what’s the big problem?

If you want to sell the property for the $1 million it’s worth today, you could potentially owe taxes on the full $800k gain when sold. Now imagine you decide to hold the property for many years to come and that $800k gain doubles to $1.6 million? We’re talking hundreds of thousands of dollars owed in taxes when it’s time to sell!

*Note: This doesn’t factor in the $500k capital gains exclusion if you and your spouse were to live in the property for two out of the last five years. Even so, $300k would still be subject to taxes. ($800k gain - $500k exclusion = $300k).

The Solution?

Have your parents essentially write you an “IOU” by listing you as the beneficiary to inherit their property when they pass away. This allows for a step-up in basis, which can result in significant tax savings.

Quick refresher: A step-up in basis means that the new basis (your basis) in the property will be the fair market value on the date of death. So if you were to inherit your parents’ property when it was worth $1 million dollars, your new basis in the property would be $1 million, not $200k.

Why is this so important? You can turn around and sell the property for $1 million and not pay a penny in taxes. That’s right, $0 owed to the IRS. That’s because you sold it for the same price as your new basis. You technically have a gain of $0. $0 gain = $0 taxes owed.

Downside to Inheriting:

There’s such a thing as federal estate taxes, but it likely won’t be an issue for most families. As of 2024, federal estate taxes apply to estates with a net value greater than $13,610,000. Even then, federal estate taxes are owed only on amounts above the $13,610,000 threshold.

However, there are some states that charge their own estate taxes with far lower thresholds, and a few states that charge an inheritance tax. Maryland is the only state to charge both an estate tax and inheritance tax.

Basically, an inheritance tax is paid by the beneficiary based on the amount they receive. An estate tax is a tax that the estate pays based on the total net value of the estate. As of 2024, only six states have an inheritance tax, so it’s not too common.

In any case, there are some creative estate planning strategies to limit or avoid estate taxes altogether. Sometimes those strategies might actually include gifting a property or other assets!

When Could it Make Sense to Receive a Gift?

As mentioned above, it sometimes makes sense to gift a property when it’s part of an overall estate tax planning strategy. Another situation could be if the property is worth about the same or less than your parents’ basis. For example: your parents purchased the home for $800k and it’s now worth $700k. Taxes aside, family dynamics or situations can also come into play when deciding whether it makes sense to gift a property or leave it as an inheritance.

Final Thought:

It goes without saying that each family’s situation is different. In some instances it actually might make sense to receive your parents’ property as a gift. However, if their idea is to simply gift you the property out of the love of their heart, it’s most likely best to wait until you can receive it as an inheritance.

Is it better for you to inherit your parents property? Schedule a complimentary intro call to learn more.