In 2018, around one in every five new home purchasers got at least part of their down payment from a relative—and of the parents who have contributed to this down payment assistance, the average gift is $39,000. With the housing market reaching new highs in many parts of the country, some parents seem poised to assist.
But what about the federal gift tax? Could this down payment (or other) assistance come with a bill from the IRS? Below, we discuss a few of the elements of the gift tax, providing you with information that may help you give gifts more mindfully.
What is the Gift Tax?
The federal gift tax is assessed on large gifts of money or property. However, most gifts aren’t subject to the gift tax. Each year, gift givers can take advantage of the annual exclusion and avoid paying any taxes on gifts below the exclusion. For 2021, the gift tax exclusion is $15,000 per person per year.
The $15,000 limit is an individual one. In other words, a married couple may gift their son $30,000 ($15,000 from each parent) and their daughter-in-law $30,000 ($15,000 each), for a total of $60,000, without owing any gift tax. And this limit resets each year. This couple could potentially make this $60,000 gift on December 31 and then gift another $60,000 on January 1 of the following year without paying tax.
In addition to the $15,000 annual exclusion, there’s a lifetime cap on tax-free gifts. However, unless you’re a multimillionaire, you’re unlikely to ever hit this cap (currently expected to be $5.5 million).
What is a Gift?
The definition of “gift” under the gift tax law may be more expansive than expected. Generally, a gift is any transfer of property under its fair market value. This may include selling a property to a family member at a reduced cost or loaning a large amount of money at less than the market interest rate.
There are also some financial transactions that aren’t considered gifts. Gifts to a spouse aren’t subject to the $15,000 annual exclusion, nor are charitable gifts or gifts for medical or educational expenses.
Are There Financial Benefits to Gifting?
Giving generous financial gifts may dip into your total assets, reducing or eliminating your estate tax liability. This can be especially true if you’re gifting an asset that is likely to significantly appreciate before you die (like real estate).
Gifting an income-producing asset (like a rental property or certain royalties) to a loved one may also reduce your income taxes. If the person receiving the gift is in a lower tax bracket than you are, they may pay any future taxes on this asset at a lower rate.
Finally, giving your loved ones financial gifts may encourage them to take an active role in their financial future. These gifts encourage your loved ones to learn more about investing or even make some gifts of their own.