Gifting equity in a home: Things to know

Effective tax planning and the preservation of family traditions may not seem likely to intersect; however, when parents gift a home with equity to their children, an opportunity presents itself. In fact, the parents may be able to accomplish both preservation of the home for future generations and potential estate and gift tax savings by moving a valuable asset out of the estate.

Consider a scenario where parents own a home valued at $1 million and intend to include it as part of their estate. If the home continues to grow in value — for example, from $1 million to $2 million over the remainder of the parents’ lives — that $2 million figure would increase the likelihood that the value of the parents’ estate would exceed the estate tax exclusion.^Footnote1

What are the potential tax implications?

As parents make their estate plans, it’s important to stay on top of lifetime gifting — the IRS sets rules and limits around gifts to individuals, and if gifts go over that limit, the recipient may have to pay taxes on the amount over the limit. For example, each parent can give each child up to $19,000 per year in 2026 without the gift counting against their lifetime exclusion. Amounts over that will be debited against the federal gift and estate tax exclusion limit.

However, there are other tax consequences to consider. For instance, if parents gift a home with equity today, the children take the parents’ original tax cost basis, plus any capital improvements. While a lifetime gift transfers equity to the children sooner, it may expose them to larger capital gains taxes in the future.

If the house were instead passed to children as part of an estate, the children would receive a “stepped-up” basis, resetting the tax cost basis at the market value on the date of the second parent’s death. That means the children would likely pay less capital gains taxes when the house is eventually sold than they would if the house were gifted by their parents.

“There’s always a trade-off between avoiding estate taxes and having to pay capital gains taxes,” says Greg Miller, senior wealth planner with Wealth & Investment Management, Wells Fargo Clearing Services, LLC. “Currently, the top federal estate tax rate is 40%. Depending on where you live, the capital gains tax can be more substantial.”

What if the parents pay the mortgage first?

If they have the money to do so, parents may choose to pay off the mortgage before gifting a home with equity.

This could make it easier for the parents if they want to give the home to more than one child, and it might eliminate some confusion over which child owns what. If the mortgage is paid off, the shared gift can create a tenancy-in-common situation where the children share ownership and management of the property. Before going this route, it’s a good idea for the parents to discuss the arrangement and responsibilities with their children, as well as their tax, legal, and financial professionals. Such arrangements should be thoroughly discussed among the parties involved. 

What if the parents do not pay the mortgage first?

Another option is for children to assume the mortgage with the gifted home. The IRS sees this as the parents accepting a partial payment for the property.

“The transaction could be considered part-gift/part-sale,” Miller explains. “A $1 million house with a $300,000 mortgage, for example, is considered a gift of $700,000.”

In this scenario, there is an important aspect to consider: If the children want to take over the mortgage, they will need to get approval from the lender. If the children have bad credit or other obstacles that would prevent them from getting a mortgage on their own, this might cause a problem with the existing lender. 

What if the parents stay in the home after gifting it?

Parents can also choose to place the home into a Qualified Personal Residence Trust with the children as beneficiaries. Doing so gives parents the right to live in the home for a stated term — 15 years, for example. The value of the reported gift is measured at the time the home is gifted into the trust, not when the children move in years later. That could benefit the children if the home appreciates in value significantly before they take ownership of it.

“Even if the house triples in value, it’s out of the parents’ estate and there’s no further gift amount applied to the lifetime exclusion,” Miller says. “However, if the parents do not survive the term of the trust, the estate is taxed as if they never made the gift.” 

Next steps

The estate and gift tax exclusions are annually adjusted for inflation. Be sure to stay connected with your financial professionals and legal and tax advisors.

“With so many complex factors at play, it is important to understand both family and tax implications of your gifting strategy,” says Miller. “Your advisors with Wells Fargo Wealth & Investment Management can work with you and your legal and tax advisors to work through the dynamics to help determine a path for gifting your home and other assets.”