Giving the Building to Your Daughter Also Gives Her the Tax Bill

Parents who have built a property portfolio often want to pass something on while they are alive: a rental for a child starting out, a building for the next generation to manage.

Done as a lifetime gift, that transfer carries a consequence most people do not expect. The recipient takes over your tax basis, including all the gain you deferred through years of exchanges, and the basis adjustment that would have applied at death is lost.

What happens to basis on a gift?

The recipient of a gift generally takes the donor's basis, adjusted in certain circumstances. That is carryover basis.

If you bought a rental for 150,000 dollars in 1998, exchanged it twice, and now hold a property worth 1.2 million dollars with an adjusted basis of 90,000 dollars, a gift transfers that 90,000 dollar basis along with the property.

Your child receives an asset worth 1.2 million dollars carrying an embedded gain of over a million.

What would happen instead at death?

Property owned at death generally receives a basis adjustment to fair market value. The same property inherited rather than gifted would pass with a basis near 1.2 million dollars.

The deferred gain and the accumulated depreciation recapture would generally be eliminated. Your child could sell shortly afterwards with little or no income tax.

The difference between the two outcomes, on this example, could be 300,000 dollars or more of tax.

Is a gift ever the right answer?

Sometimes, for reasons other than income tax.

Estate tax planning. For estates large enough to face estate tax, removing an appreciating asset and its future growth from the estate can be valuable, even at the cost of the basis adjustment.

Control and timing. You may want the next generation to take responsibility now rather than later.

Family circumstances. Helping a child with a specific need can matter more than optimising tax.

Low basis is not always the issue. Recently acquired property with little appreciation loses little from carryover basis.

The point is to make the choice knowingly, weighing income tax against estate tax and family objectives, rather than discovering the consequence afterwards.

What about gift tax?

Lifetime gifts above the annual exclusion generally require a gift tax return and use part of the lifetime exemption. Tax is often not payable, but reporting is required, and the exemption used is no longer available at death.

Gift and estate tax thresholds change with legislation, so current figures should be confirmed rather than assumed.

Does gifting affect a 1031 exchange?

It can. Gifting property shortly after acquiring it in an exchange raises the question whether you held it for investment, which is a requirement on the replacement side. A gift soon after closing invites the argument that the property was never held for investment by you.

Holding the replacement property for a meaningful period, operating it as a rental and reporting it as such, strengthens the position considerably.

What are the alternatives?

Leave it at death. Simplest, and preserves the basis adjustment.

Gift a partial interest over time. Annual exclusion gifts of fractional interests, with valuation considerations.

Sell to the child. Creates a market transaction, but related party rules and the loss of the basis adjustment both need thought.

Use a trust. Various structures balance control, estate tax and basis outcomes. This is specialist territory.

Exchange into something easier to divide. Several smaller properties, or fractional interests, can be allocated among children at death without partitioning a building.

What about gifting to charity?

Different rules and often favourable ones. Appreciated property held long term and donated to a qualifying charity can produce a deduction based on fair market value without recognising the gain. Depreciation recapture and other limits apply, so advice is needed.

What to do first

Before gifting any appreciated property, ask your CPA for two numbers: the recipient's basis if you gift it now, and their basis if they inherit it. Then ask your estate attorney whether estate tax exposure justifies the gift anyway. For most families, the basis adjustment at death is worth more than the gift, and the answer changes only when the estate is large.

Nothing here is tax, legal or investment advice. Gift and estate rules change. Confirm your plan with your CPA and estate attorney before transferring anything.