Gifts of Property & Relevant Legal Concerns
People sometimes gift property to heirs and loved ones before death. Gifts of property before death avoid probate for the simple reason that the decedent no longer owns the property when they die. Even if an individual does not gift their entire estate before they die, their estate may still avoid formal probate proceedings by qualifying for small estate procedures. However, gifts of property may still be subject to other considerations, such as taxes and liability for debts.
Gift and Estate Taxes
Gifting property before death will not avoid estate taxes. The federal estate tax exemption applies to property given away during life or left at death. For 2021, this means that an individual may make up to $11.7 million in tax-free before- or after-death gifts. Only gifts greater than the annual gift exclusion ($15,000 per year in 2021) to any one person or non-charitable institution are subject to gift tax.
The IRS defines a gift as “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.” Put another way, any transfer of property to another party in which the transferee gives less than full value in exchange for that property is a gift. The IRS generally excludes tuition or medical expenses paid for someone else, gifts to a spouse, and gifts to political organizations for the use of the organization. Gifts to qualifying charities are deductible from the value of gifts made. However, gifts other than deductible charitable contributions are not deductible from federal income tax.
Capital Gains Tax
An individual who sells an asset that they received as a gift may incur different capital gains tax liability than if they had inherited the same asset after the owner’s death. Capital gains tax is calculated by using an item’s tax basis. This is usually its purchase price, but there is an exception for inherited property called the stepped-up basis rule. Under this rule, the tax basis of inherited property is the value of the property as of the date of death. If the value of the property at the date of death is greater than its original tax basis (likely its purchase price), the increased tax basis will decrease capital gains tax liability.
The stepped-up basis rule does not apply to gifts received during the original owner’s life. If the asset’s value has appreciated since the original owner purchased the item, the new owner may incur more capital gains tax liability than if they had inherited the same item after death.
Debt and Gifts
Any debts attached to a gift, such as a car loan, will be transferred to the recipient along with the gift. This means that the recipient will become liable for any debts associated with the gift and may be subject to creditor claims. If a gift is associated with a large amount of debt, the formal probate process may give the recipient more protection by securing an official creditor claim deadline.
A gift under which a recipient becomes a co-owner may also cause creditor issues. Creditors may sometimes reach jointly owned property. Therefore, property co-owned by an individual with debts could be lost entirely to creditors.