The days of parents giving over their homes and letting children ‘take over’ are gone. Today, the IRS may want taxes on the transaction depending on the cost basis and the home’s current value. The IRS set these rules to avoid the ‘unlawful transfer’ of property to avoid taxes.

While you (the receiver) may not owe taxes, your parents may if they gift a house. Understanding the rules and the ways ‘out’ will help your parents avoid a large tax bill down the road.

Here’s how it works.

The IRS Gift Tax Rules

The IRS allows a single person to gift money or assets up to $15,000 per year tax-free. If you’re married, that means together you could gift $30,000 and not face tax consequences.

Most houses are worth a lot more than $15,000 or $30,000, though. This may leave your parents with a tax liability on the remaining amount but after certain calculations.

The Cost Basis

First, your parents must know the home’s cost basis. How much did they pay for the home? Next, they should know the home’s current value. The cost basis is the difference between the two.

For example, if your parents bought a home for $100,000 and today it’s worth $300,000, the cost basis is $200,000. The IRS calculates the gift tax on that amount.

Avoiding the Gift Tax

Using our example from above, it looks like your parents owe taxes on $200,000, but they don’t.

First, you can deduct the ‘free money’ the IRS allows them to gift. If your parents are married, that’s $30,000. This brings the cost basis down to $170,000.

Now, your parents may use their lifetime ‘unified credit.’ Everyone is eligible for this. In 2020, the unified credit is $11,580,000. This means your parents’ estate is sheltered from tax liability up to $11,580,000. If your parents know their estate isn’t worth that much, they can use a portion of the unified credit today.

If they use the credit, your parents can avoid the tax liability of offering you a gift house. Their unified credit will reduce to $11,410,000 after you deduct the $30,000 gift tax credit.

Paying the Gift Tax

If your parents don’t want to use their unified credit, they would owe taxes on the $170,000 cost basis. They must complete IRS Form 709 to report the gift. If both parents gifted the home, both parents must complete a separate Form 709. The cost basis of the home, and the taxes owed, get evenly split between both parents even if they’re married.

If your parents gift you a house, consider yourself lucky! You don’t owe taxes on the transaction, and your parents may avoid them. Get the advice of a tax professional before conducting the transaction. Ensure it makes financial sense the way you set it up. Since most people’s estates don’t exceed the $11,580,000 limit, most parents can avoid the tax, but it’s best to get professional advice.