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George Saenz, the Tax Talk columnistGift of free house has tax consequences

Dear Tax Talk,
My father wants to gift my wife and I a house. He wants to do it as a one-time gift -- not in increments. The home is appraised at $530,000 and the basis is $12,000. There is currently one mortgage of $115,000.

Using the unified gift credit of $1 million, would he have to pay any tax at all or just on the difference between the $12,000 basis and the original loan amount of $140,000, which was a cash-out refi many years ago.

Thank you for helping with this matter.
-- Derek

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Dear Derek,
You certainly don't want to look a gift house in the mouth, but before you saddle up, you need to consider some pitfalls. First, since your dad's cost in the property is less than his debt, he'll have a capital gain on the transfer by gift to you. The gain is the difference between the current debt (the $115,000, not the $140,000) and his cost basis. The remainder will be gift-tax free based on the unified credit.

The next issue is your cost in the property. Transfers by gift receive a carry-over basis (the donor's cost), plus any gain recognized by your dad. This means your cost basis on a later sale will be the amount of the mortgage you assume, which includes your dad's cost. (It's an algebraic equation wherein Dad's gain = mortgage less cost, or $115,000 - $12,000. So son's cost basis = Dad's gain plus cost, or $103,000 + $12,000. Therefore the son's cost basis is the mortgage amount, or $115,000.)

If you hang on to the house for a few years, your gain at that time might then exceed the maximum exclusion of $500,000 from the sale of a primary residence. Since the numbers are rather large, I suggest you consult with a CPA on how best to structure this transfer.

To ask a question on Tax Talk, go to the "Ask the Experts" page, and select "taxes" as the topic.'s corrections policy -- Posted: May 31, 2006
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