If you own something, you should be able to give it to someone else – right???
Yes, you can give away assets that you own – but, unfortunately, not without potential tax consequences. Before gifting appreciated assets such as rental properties, it is important to understand the applicable tax rules.
For purposes of determining potential tax obligations, a gift is considered to be the transference of an asset to another person at less than the asset’s market value. Gifting appreciated assets can result in tax obligations for both the donor and potentially the recipient of the gift.
The Internal Revenue Service's gift tax may apply if you give an individual property while receiving nothing or less than the asset's full market value in return. If you sell the gifted property rather than inheriting it, capital gains taxes can also be a factor.
Triggering a Gift Tax
Any kind of transfer of money or property, including income from the transferred property to a third party without obtaining something of equal value in return, is subject to gift tax. Normally, the individual donating the asset (the donor) is liable for paying the tax, however there are several instances where the recipient may incur tax liability.
Monetary gifts (cash) are subject to a gift tax but since they won't appreciate in value, there is typically no need to worry about capital gains taxes.
The tax consequences of gifting of rental properties are more complex since the recipient of the gift receives the property at the adjusted cost basis of the donor.
For example, if you gift a rental property that you purchased 10 years ago for $200,000 that is now worth $500,000, the recipient will receive the property valued at your adjusted cost basis i.e., the original purchase price of $200,000 less any depreciation plus capital improvements.
If the recipient decides to sell the rental property, they could be subject to not only capital gains taxes, but depreciation recapture, state income taxes, and the net investment (aka Obama Care tax) which could total up to 40% for California residents.
The Gift Tax Exclusion
With the exception of Connecticut, which is the only state with a gift tax, gift taxes are paid at the federal level. Federal tax code provides for gift tax exclusions which vary from year to year. In 2022, the gift tax exclusion was $16,000 and increased to $17,000 in 2023. For example, parents can gift up to these amounts to their children without incurring a gift tax.
If the gift value exceeds these amounts, gift taxes are not owed until the donor exceeds their allowed lifetime gift and estate tax exemption which is $12.92 million or $25.84 million per married couple.1
Donors who gift more than the annual tax exclusion amount must file a Form 709 with their federal tax return to allow the government to keep track of accrued total gifts over their lifetime.2
Minimizing Gift Taxes
1. One of the best strategies to avoid creating gift taxes on a rental property is to bequeath the property to a chosen heir as part of your estate plan after you pass. When you pass, the property is transferred to the heir at the asset's stepped-up basis, which is its current fair market value, and all of the aforementioned taxes are forgiven.
Using our earlier example, the heir would take ownership of the rental property with a cost basis of $500,000 and could immediately sell it for that sum without creating a taxable event. They would however be responsible for paying taxes on any incremental gains that might be realized should they decide to hold onto the property. The amount of taxes due would depend on how long the successor owned the asset before selling it.
2. The heir may also reduce their tax exposure by moving into the rental property and establishing residency for a minimum of two years. In doing so, they may qualify for a 121-tax exclusion which could reduce their capital gains taxes by $250,000 if single or $500,000 for married couple.3
3. You can put your rental property in an irrevocable trust which can transfer the property to your heir after you pass. Since rental property in irrevocable trusts are no longer part of your estate, the estate and gift tax taxes limitation won't apply to the transfer of property to your heir.
Note that when a rental property is held under an irrevocable trust, it cannot generally be removed. The proceeds from the sale of the rental property, if you choose to do so, will remain in the irrevocable trust.
4. The lifetime limits discussed previously include the combined value of both gifts and your estate, i.e., everything else comprising your net worth. You can take steps to increase the amount that can gift tax-free by reducing the value of your estate.
One option is to move assets in your estate to an irrevocable trust that you create. Since the assets officially cease to be your property as soon as you transfer money or other assets into the irrevocable trust, they can significantly lessen the amount of your taxable estate.
Gifting Without Triggering a Gift Tax
There are several ways of gifting unlimited amounts of assets without triggering a gift tax.
Spouse: As long as your spouse is a citizen of the United States, you are able to transfer any amount of money or property to them tax-free. The IRS puts an annual cap on the amount you can contribute tax-free if your spouse is not a citizen. The limit is $164,000 for tax year 2022 and $175,000 for tax year 2023.
Charities: The IRS may allow a donation made to a recognized non-profit organization to count as a taxable gift. To find out which groups qualify for the exemption, speak with a financial counselor or tax expert as this may differ between states.
Medical Institutions: It might not be taxable if you pay for another person's eligible medical costs. The money must, however, be sent directly to the caregiver. The advice of a tax expert should be sought if you want to do this.
Determining tax consequences of gifting assets such as rental properties can be complicated and we encourage all readers to consult with experienced tax professionals before gifting appreciated properties. Intuitively, many rental property owners think it is preferable to simply gift rental properties to their children before they pass and do not realize that they are passing on potential significant tax burdens that could have been avoided through following a well-though out estate plan.4
Please contact us for more information on tax advantaged real estate investments and for referrals to tax and estate planning specialists.
1. Per current tax code, as of January 1, 2026, the current lifetime estate and gift tax exemption will be cut in half and adjusted for inflation.
4. This blog was intended to introduce high level concepts and we intentionally avoided many related topics such as property transfers in a divorce, due on sale clauses for properties with mortgages, and 529 college savings plans, among others.