Do You Owe Taxes On That Gift?

As a Certified Financial Planner, I'm often asked aboutimplications so check with an accountant.)
issues regarding inheritance, gifting and the resultingInheritances aren't subject to Federal Estate Tax
taxes. Here's a classic example of just howunless the estate's value is over a certain amount,
complicated these situations can be, using a questionwhich is currently two million dollars. Because all assets
from a reader in Michigan we'll call Bob.owned by the deceased are included in the estate's
Bob writes, "I have a question about my mom's homevaluation (i.e. retirement accounts, annuities, life
that I inherited. Before my mom died she put her realinsurance, etc.), reaching that two million dollar limit is
estate into joint ownership between her and my sister.easier than you think.
It was supposed to help make settling her estateEven if there is no gift or estate tax when the assets
easier. Before mom passed away, my sister died.are transferred, there can be capital gain taxes when
After my sister died, mom placed the real estate jointlythe assets are sold. The trick is determining the asset's
between herself and me. Mom passed away over aoriginal value, or cost basis, and that depends on
year ago and I am now contemplating the sale of herwhether the asset was a gift or an inheritance.
house. After mom's death I had the home transferredWhen you receive a gift, you also receive the cost
to my and my wife's names.basis the person giving the gift had. So, if a parent paid
What are my capital gains liabilities on the sale of the$10,000 for a home and it was worth $100,000 when it
house? Do I pay capital gains on the whole sale, halfwas gifted to the child, the child now has a cost basis
the sale, or none of the sale?"of $10,000. If the house is sold 5 years later for
Bob's lack of knowledge is nothing out of the ordinary.$125,000, the child will owe taxes on a gain of $115,000.
Few people are aware of the tax implications andIf the house was instead inherited by the child, the cost
needlessly end up creating a tax headache forbasis is the value of the house at the time of
themselves and their loved ones.inheritance, which in our example would be $100,000.
Let's explain what an inheritance is and how it differsSo when the house is sold 5 years later for $125,000,
from a gift. An inheritance is money, property, orthe child only owes taxes on the gain of $25,000. In
another asset of value that is transferred after death.tax parlance, the house received a step-up in basis
A gift occurs when money, property or other assetswhen transferred after death. It doesn't receive a
are transferred before death. An inheritance and a giftstep-up if transferred prior to death.
are handled very differently from a tax standpoint.Let's apply this to Bob's situation. When Mom added
Each of us can give gifts up to $12,000 per year toSister's name to the deed, it was a gift to the sister of
any person we want without any Federal tax50% of the value of the home and Sister's cost basis
implications. (There may be some state gift taxwas 50% of Mom's cost basis.