Maximizing Benefits and Navigating Pitfalls: Understanding the Tax Implications of Inheriting or Receiving a Home as a Gift Article Highlights:

Gifting Considerationso Gift Tax Returno Gift Basiso Holding Periodo Home Sale Exclusiono Capital Gainso Special Considerations
Inheritanceo Inherited Basiso Depreciation Reset
Comparison

A frequent question, and a situation where taxpayers often make tax mistakes, is whether it is better to receive a home as a gift or as an inheritance. It is generally more advantageous tax-wise to inherit a home rather than to receive it as a gift before the owner's death. This article will explore the various tax aspects related to gifting a home, including gift tax implications, basis considerations for the recipient, and potential capital gains tax implications. Here are the key points that highlight why inheriting a home is often the better option.
RECEIVED AS A GIFT
First let's explore the tax ramifications of receiving a home as a gift. Gifting a home to another person is a generous act that can have significant implications for both the giver (the donor) and the recipient (the donee), especially when it comes to taxes. Most gifts of this nature are between parents and children. Understanding the tax consequences of such a gift is crucial for anyone considering this option.
Gift Tax Implications - When a homeowner decides to gift their home to another person (whether or not related), the first tax consideration is the federal gift tax. The Internal Revenue Service (IRS) requires individuals to file a gift tax return if they give a gift exceeding the annual exclusion amount, which is $18,000 per recipient for 2024. This amount is inflation adjusted annually. Where gifts exceed the annual exclusion amount, and a home is very likely to exceed this amount, it will necessitate the filing of a Form 709 gift tax return.
It's worth mentioning that while a gift tax return may be required, actual gift tax may not be due thanks to the lifetime gift and estate tax exemption. For 2024, this exemption is $13.61 million per individual, meaning a person can gift up to this amount over their lifetime without incurring gift tax. The value of the home will count against this lifetime exemption.
Note: The lifetime exclusion was increased by the Tax Cuts and Jobs Act (TCJA) of 2017, which without Congressional intervention will expire after 2025, and the exclusion will get cut by about half.
Basis Considerations for the Recipient – For tax purposes basis is the amount you subtract from the sales price (net of sales expenses) to determine the taxable profit. The tax basis of the gifted property is a critical concept for the recipient to understand. The basis of the property in the hands of the recipient is the same as it was in the hands of the donor. This is known as "carryover" or "transferred" basis.
For example, if a parent purchases a home for $200,000 and later gifts it to their child when its fair market value (FMV) is $500,000, the child's basis in the home would still be $200,000, not the FMV at the time of the gift. If during the parent's time of ownership, the parent had made improvements to the home of $50,000, the parent's 'adjusted basis' at the time of the gift would be $250,000, and that would become the starting basis for the child.
If a property's fair market value (FMV) at the date of the gift is lower than the donor's adjusted basis, then the property's basis for determining a loss is its FMV on that date.
This carryover basis can have significant implications if the recipient decides to sell the home. The capital gains tax will be calculated based on the difference between the sale price and the recipient's basis. If the home has appreciated significantly since it was originally purchased by the donor, the recipient could face a substantial capital gains tax bill upon sale.
Home Sale Exclusion – Homeowners who sell their homes may qualify for a $250,000 ($500,000 for married couples if both qualify) home gain exclusion if they owned and used the residence for 2 of the prior 5 years counting back from the sale date. However, when a home is gifted that gain qualification does not automatically pass on to the gift recipient. To qualify for the exclusion the recipient would have to first meet the 2 of the prior 5 years qualifications. Thus, where the donor qualifies for home gain exclusion it may be best taxwise for the donor to sell the home, taking the gain exclusion and gift the cash proceeds net of any tax liability to the donee.
Of course, there may be other issues that influence that decision such as the home being the family home that they want to remain in the family.
Capital Gains Tax Implications - The capital gains tax implications for the recipient of a gifted home are directly tied to the basis of the property and the holding period of the donor. If the recipient sells the home, they will owe capital gains tax on the difference between the sale price and their basis in the home. Given the carryover basis rule, this could result in a significant tax liability if the property has appreciated since the donor originally purchased it. Capital gains are taxed at a more favorable rate if the property has been held for over a year. For gifts the holding period is the sum of the time held by the donor and the donee, sometimes referred to as a tack-on holding period.
Special Considerations - In some cases, a homeowner may transfer the title of their home but retain the right to live in it for their lifetime, establishing a de facto life estate. In such situations, the home's value is included in the decedent's estate upon their death, and the beneficiary's basis would be the FMV at the date of the decedent's death, potentially offering a step-up in basis and significantly reducing capital gains tax implications, i.e., treated as if they inherited the property.
AS AN INHERITANCE
There are significant differences between receiving a property as a gift or by inheritance.
Basis Adjustment - When you inherit a home, your basis in the property is generally "stepped up" to the fair market value (FMV) of the property at the date of the decedent's death. However, occasionally this could result in a 'step-down' in basis where a property has declined in value. Nevertheless, this day and age, most real estate would have appreciated in value over the time the decedent owned it, and the increase in value will not be subject to capital gains tax if the property is sold shortly after inheriting it.
For example, if a home was purchased for $100,000 and is worth $300,000 at the time of the owner's death, the inheritor's basis would be $300,000. If the inheritor sells the home for $300,000, there would be no capital gains tax on the sale.
In addition, the holding period for inherited property is always considered long term, meaning inherited property gain will always be taxed at the more favorable long-term capital gains rates.
Note: The Biden administration's 2025–2026 budget proposal would curtail the basis step-up for higher income taxpayers.
In contrast, if a property is received as a gift before the owner's death, the recipient's basis in the property is the same as the giver's basis. This means there is no step-up in basis, and the recipient could face significant capital gains tax if the property has appreciated in value, and they decide to sell it.
Using the same facts as in the example just above, if the home was gifted and had a basis of $100,000, and the recipient later sells the home for $300,000, they would potentially face capital gains tax on the $200,000 increase in value.
Depreciation Reset - For inherited property that has been used for business or rental purposes, the accumulated depreciation is reset, allowing the new owner to start depreciation afresh on the inherited portion and since the inherited basis is FMV at the date of the decedent's death, the prior depreciation is disregarded. This is not the case with gifted property, where the recipient takes over the giver's depreciation schedule.
Given these points, while each situation is unique and other factors might influence the decision, from a tax perspective, inheriting a property is often more beneficial than receiving it as a gift. However, it's important to consider the overall estate planning strategy and potential non-tax implications.
Please contact this office for developing a strategy that is suitable for your specific circumstances.
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Make Next Year Better: Tips for Managing the Change from QB Desktop to Online Tax season is over. Take a deep breath – whether you’re a bookkeeper or tax preparer, you’ve endured plenty of stress these past months, and now you’re in the perfect space between vacation and conference season to look back and figure out how to make it go better next year. That’s what we do in …
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Video Tips: Careful Tossing Out Old Tax Records Now that April 15 has come and gone, taxpayers are wondering what old tax records can be discarded. There is no fixed timeline, as it depends on the type of records and whether there were any omissions on the related tax return.
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Navigating the R&D Tax Credit Maze: What SMBs Need to Know Amid Legislative Uncertainty The landscape of tax legislation in the United States has been marked by constant evolution, with changes often reflecting the broader economic and political priorities of the time. One area that has seen significant shifts, and consequent uncertainty, involves the treatment of research and development (R&D) expenses. Historically, businesses could immediately deduct R&D expenses in the year they were incurred, a provision that encouraged innovation and investment in new technologies.
However, the Tax Cuts and Jobs Act (TCJA) of 2017 introduced a significant change that has since cast a shadow of uncertainty over the ability of companies to deduct these expenses: the requirement to amortize R&D expenses over five years, or fifteen years for research conducted outside the U.S., starting from the midpoint of the tax year in which the expenses were paid or incurred.
This shift, effective for tax years beginning after December 31, 2021, represents a departure from previous tax treatment and poses a challenge for businesses engaged in R&D activities. The immediate deduction of R&D expenses was a critical factor in lowering the effective cost of investment in innovation. By spreading the deduction over several years, the TCJA provision increases the short-term tax burden on companies, potentially discouraging investment in R&D activities that are crucial for technological advancement and economic growth.
The Impact of Amortization
The requirement to amortize R&D expenses affects cash flow and financial planning for businesses. Immediate expensing allows companies to reduce their taxable income in the year expenses are incurred, providing a more immediate cash benefit. Amortization, on the other hand, delays this benefit, which could lead to reduced investment in R&D due to tighter cash flow, especially for startups and small businesses that are often more sensitive to cash flow constraints.
Moreover, the change complicates tax planning and increases administrative burdens. Companies must track R&D expenses over the amortization period, adjusting for any changes in their R&D investment strategies. This complexity adds to the cost of compliance and may divert resources away from productive R&D activities.
Legislative Responses and Uncertainty
In response to concerns raised by the business community and tax professionals, bipartisan bills have been introduced in both the House of Representatives and the Senate aiming to repeal the amortization requirement. If enacted, these bills would allow companies to continue fully deducting R&D expenses in the year they are incurred, maintaining the United States' competitive edge in innovation and technology development.
However, the legislative process is inherently uncertain, and the outcome of these proposals is not guaranteed. The uncertainty surrounding the tax treatment of R&D expenses makes it difficult for businesses to plan their investment strategies. Companies may adopt a more cautious approach to R&D spending, awaiting clearer signals from Congress and the administration on the future of these tax provisions.
Early in 2024, a glimmer of hope emerged with the proposal of the Tax Relief for American Families and Workers Act, aimed at reversing these changes. However, the legislative process has been slow, leaving businesses in a state of limbo. The implications of this uncertainty are profound, influencing the way R&D expenses are reported.
The Potential Outcomes and Their Implications
Should the bill pass retroactively, businesses would once again be able to fully expense U.S.-based R&D costs for the current tax year through 2025. This would delay the requirement to amortize these expenses, providing significant relief.
However, if the bill does not become law, the current requirements under Section 174 will persist, necessitating the amortization of R&D expenditures over the stipulated periods. This could considerably impact your business's financial planning and tax liabilities.
Alternative R&D Credit for Small Businesses
Amidst this uncertainty, there is a silver lining for small businesses in the form of the Research and Development (R&D) Tax Credit. This credit, aimed at encouraging businesses to invest in research and development, has been made more accessible to small businesses, including startups, through recent legislative changes.
For tax years beginning after December 31, 2015, qualified small businesses can elect to apply a portion of their R&D tax credit against their payroll tax liability, up to a maximum of $250,000 ($500,000 after December 2022). This provision, part of the Protecting Americans from Tax Hikes (PATH) Act, is particularly beneficial for startups and small businesses that may not have a significant income tax liability but still incur substantial payroll expenses.
To qualify, a business must have less than $5 million in gross receipts for the tax year and no gross receipts for any tax year preceding the five-tax-year period ending with the tax year.
This definition opens the door for many startups and small businesses to benefit from the R&D tax credit, supporting their investment in innovation even in the early stages of their development.
The Future
The legislative uncertainty surrounding the ability to deduct R&D expenses or having to amortize them over five years poses a significant challenge for businesses engaged in research and development. The potential shift from immediate expensing to amortization could have far-reaching implications for innovation, cash flow, and tax planning. As Congress considers proposals to repeal the amortization requirement, businesses must navigate this uncertainty, potentially adjusting their investment strategies to account for the changing tax landscape.
For small businesses, the R&D tax credit offers a valuable opportunity to offset some of the costs associated with innovation, providing a critical lifeline amidst broader legislative uncertainty. By allowing small businesses to apply the credit against payroll taxes, the government is reinforcing its commitment to fostering innovation across all sectors of the economy.
As the debate over the treatment of R&D expenses continues, it is clear that the outcome will have significant implications for the future of innovation in the United States.
Businesses, policymakers, and tax professionals alike must stay informed and engaged to ensure that the tax code supports, rather than hinders, investment in the technologies and ideas that will drive economic growth in the years to come.
How We Can Help
As your accounting partners, we understand the complexities and challenges the current legislative environment poses. We are committed to keeping you informed and providing strategic advice tailored to your situation. Whether you're currently engaged in R&D activities or planning for future innovation, we can help you navigate the tax implications and explore all available options to optimize your financial position.
Our team closely monitors legislative developments and is ready to assist you in evaluating their potential impact on your business. Should the need arise, we can also guide you through filing for an extension or amending your tax returns to take advantage of any changes in the law.
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Essential Tax Benefits Every Parent of a Disabled Child Should Know About Article Highlights:

Special Schooling
Learning Disabilities
Non-Hospital Institutions
Medical Conferences
Auto Travel
Trips
Meals
Lodging
Vehicle Modifications
Drug Addiction
Home Modifications
Childcare Credit
Nursing Services

For families who have disabled children or children with special needs, tax laws provide opportunities to save substantial amounts of money at tax time. Here is a rundown of tax-deductible expenses that parents may benefit from in addition to normal medical expenses.
Special Schooling - For a child diagnosed with learning disabilities, tuition paid to attend a school designed to assist students in overcoming their disabilities and developing appropriate social and educational skills is a deductible medical expense.
Treating a child's learning disabilities can place a heavy financial burden on parents and the tax law may help by allowing a deduction for the cost of educating such a child.
However, like other deductible medical expenses, this cost is deductible only to the extent that medical expenses for the year cumulatively exceed 7.5% of the taxpayer's adjusted gross income.
Medical care includes the cost of attending a special school designed to compensate for or overcome a physical handicap, in order to qualify the individual for future normal education or for normal living. This includes a school for the teaching of Braille or lip reading. The principal reason for attending must be the special resources for alleviating the handicap. The cost of tuition for ordinary education that is incidental to the special services provided at the school, and the cost of meals and lodging supplied by the school, also are included as a medical expense. The distinguishing characteristic of a special school is the substantive content of its curriculum, which may include some ordinary education, but only if the ordinary education is incidental to the school's primary purpose of enabling students to compensate for or overcome a handicap.
Where a school uses special teaching techniques to assist its students in overcoming their condition, and those techniques along with the care of other staff professionals are the principal reasons for the child's enrollment at the school, then the school is a 'special school'. Thus the child's tuition at the school in those years the child is diagnosed as having a medical condition that handicaps his ability to learn are deductible.
If a school attended by a student with a medical problem doesn't qualify as a special school because the ordinary education isn't incidental to the special services provided, the costs of the special program or special treatment (but not the entire tuition) may still be a deductible medical expense.
Non-Hospital Institutions - The following are examples taken from Tax Court cases or IRS rulings of when expenses for nonhospital institutions are deductible:

All amounts paid by the taxpayer to maintain his mentally disabled son in a specially selected private home (which qualified as an 'institution' in accordance with the recommendation of the psychiatrist in charge of the son's case, to help the son adjust to life in the community after living in a mental hospital.
Hotel meals and lodging, where taxpayer stayed in and received nursing service in the hotel, after getting appendicitis, having surgery in a hospital and being discharged from the hospital because it needed his hospital room. All these events took place in New York, while the taxpayer lived in Milwaukee. At the time of his discharge, the attending physician said the taxpayer was too weak to travel home.
Amounts paid to maintain a child at a halfway house, including room and board. Admission to the halfway house required the recommendation of a psychiatrist and continued psychiatric supervision during the stay. The house staff included a psychiatrist and mental health counselor.

Medical Conferences - IRS has ruled that a taxpayer may deduct the cost of attending a conference relating to a dependent's disease or disablement. In this ruling, the taxpayer was allowed to deduct the cost of the conference registration fee and travel to the conference, because those costs were primarily for a dependent's medical care and the taxpayer's attendance was essential for that care. The costs of meals and lodging were not deductible, because the dependent did not receive medical care at a licensed facility (a prerequisite for medical deduction of meals and lodging).
Auto Travel – When using a vehicle for medical reasons, deduction is allowed at a specified rate (cents) per mile (21 cents per mile for 2024 down from 22 cents per mile in 2023) or for actual cost of gas and oil (not repairs, maintenance, depreciation, lease fees, etc.).
Trips - Amounts paid for transportation to another city may be included in medical expenses, if the trip is primarily for, and essential to, receiving medical services. Up to $50 per night for lodging may be included. A trip or vacation taken merely for a change in environment, improvement of morale, or general improvement of health cannot be included in medical expenses, even if the trip is made on the advice of a doctor.
Meals -Medical expenses may include 100% of the cost of meals at a hospital or similar institution if the main purpose for being there is to get medical care. The cost of meals that are not part of inpatient care may not be included.
Lodging - The cost of meals and lodging at a hospital or similar institution may be included if the main reason for being there is to receive medical care. Medical expenses may also include the cost of lodging not provided in a hospital or similar institution. The cost of such lodging while away from home may be included if all the following requirements are met:

1) The lodging is primarily for and essential to medical care.
2) The medical care is provided by a doctor in a licensed hospital or in a medical care facility related to, or the equivalent of, a licensed hospital.
3) The lodging is not lavish or extravagant under the circumstances.
4) There is no significant element of personal pleasure, recreation, or vacation in the travel away from home.

The amount included in medical expenses for lodging cannot be more than $50 for each night for each person. Lodging is included for a person for whom transportation expenses are a medical expense because that person is traveling with the person receiving the medical care. For example, if a parent is traveling with a sick child, up to $100 per night is included as a medical expense for lodging. Meals are not deductible.
Vehicles & Vehicle Modification - Medical expenses include the cost of special hand controls and other special equipment installed in a car for the use of a person with a disability. Medical expenses also include the difference between the cost of a regular car and a car specially designed to hold a wheelchair.
Drug Addiction - Amounts paid by a taxpayer to maintain a dependent in a therapeutic center for drug addicts, including the cost of the dependent's meals and lodging, are deductible medical expenses.
Home Modifications- Amounts paid for special equipment installed in the home, or for improvements may be included in medical expenses, if their main purpose is medical care for the taxpayer, the spouse, or a dependent. The cost of permanent improvements that increase the value of the property may be partly included as a medical expense. The cost of the improvement is reduced by the increase in the value of the property. The difference is a medical expense. If the value of the property is not increased by the improvement, the entire cost is included as a medical expense. In this situation it is recommended that a qualified professional be engaged to make the appraisal.
While the tax rules don't require a prescription from a doctor for most medically related home modifications, the taxpayer, if questioned by the IRS, needs to be able to demonstrate how the expenditure is related to medical care of the dependent. And having a letter from the individual's doctor that explains the type of modifications that would be medically beneficial would help to prove a medical need.
Only reasonable costs to accommodate a home to a disabled condition are considered medical care. Additional costs for personal motives, such as for architectural or aesthetic reasons, are not medical expenses.
Childcare Credit -A tax credit is available to some taxpayers for the expenses they incur for the care of a child or other dependent while the taxpayer is gainfully employed (or is job seeking). The expenses allowable in computing the credit are limited to earned income. For taxpayers who file joint returns, the expense is limited to the earned income of the lower paid spouse. The credit is a percentage (ranging from 20% to 35%) of the childcare expenses (limited to $3,000 per year for one child and $6,000 two or more) based on the parent's income. The larger the income the smaller the credit.
Nursing Services - Wages and other amounts paid for nursing services can be included in medical expenses. Services need not be performed by a nurse if the services are of a kind generally performed by a nurse. This includes services connected with caring for the patient's condition, such as giving medication or changing dressings, as well as bathing and grooming the patient. These services can be provided in the home or another care facility. In-home care providers are generally treated as employees, with appropriate payroll tax filings and payments needing to be made by the hiring taxpayer. Alternatively, care providers may be hired through an agency that handles all the paperwork.
If you have questions related to these or other medical deductions, please give this office a call.
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