A gift of equity can seem like a good idea between family members or other close connections. The sale, usually of property, is at a price below appraised market value; the price difference is the gift of equity.
But it’s a sweet idea that needs forethought.
“People who wish to sell their home to family members at a discount are often motivated by generosity, and it’s easy to overlook potential tax consequences,” said Erik Orbach, wealth advisor at Kayne Anderson Rudnick in Los Angeles.
“The details drastically impact income and estate/gift tax results of this scenario,” said Phillip Ross, CPA and senior wealth advisor at Exencial Wealth Advisors in Oklahoma City.
“This is also referred to as a bargain sale gift,” said Craig Richards, head of tax services at Fiduciary Trust International in New York. “There will be gain to the seller on the difference between proceeds received from the buyer and the cost basis of the residence.”
Tax issues, said Neil V. Carbone, partner at Farrell Fritz, P.C., in New York, include gift tax and income tax. A sale for less than fair market value involves a partial gift. If the amount of the gift exceeds certain thresholds, the gift would have to be reported by the donor on a gift tax return and it could trigger a gift tax.
Gain in the sale, between the discounted price and the seller’s basis, would likely be reported on the seller’s tax return.
Income tax treatment is somewhat more complicated, Carbone said. The fair market value of the residence will exceed the parent’s income tax basis. The donor will recognize a gain to the extent the purchase price exceeds the basis plus possibly the amount that can be excluded from gain on the sale of a residence.
The recipient’s basis will be the amount he or she actually paid, rather than the fair market value of the residence. “But things get a little more complicated if the donor’s basis exceeds fair market value,” Carbone said. Selling the residence in the future, for instance, will incur a larger capital gain than if the recipient had paid fair market value.
“Even if a gift tax return is required, it doesn’t mean there is a tax due,” Ross added. “The gift giver/seller, at a discount, is simply reporting to the IRS a reduction in their lifetime exemption by the amount of the discount, or gifts that exceed the annual exemption within that year.”