Real Estate Tax Calc
A worked example: what the gift actually transfers
Numbers make the carryover-basis rule concrete. Suppose you bought a residential rental property 15 years ago for $400,000 (allocating the full purchase price to the depreciable building for simplicity). Over 15 years at the straight-line 27.5-year rate, you claimed annual depreciation of $400,000 / 27.5 = $14,545 per year, totaling $218,182 of cumulative depreciation. Your adjusted basis today is $400,000 − $218,182 = $181,818.
The property is now worth $550,000. You gift it to your adult child.
Your child receives:
- Carryover basis: $181,818 — the same low adjusted basis you had, not the $550,000 fair market value.
- Built-in gain: $368,182 ($550,000 − $181,818), of which $218,182 is unrecaptured Section 1250 gain taxed at up to 25%, and $150,000 is additional long-term capital gain taxed at 0%/15%/20% depending on income.
- Remaining depreciation schedule: 12.5 years left (27.5 − 15 = 12.5), at $14,545 per year, on the basis of $181,818.
- Your holding period: Your 15-year holding period tacks onto the child's under IRC § 1223(2). A sale the day after the gift still qualifies for long-term capital-gains rates.
If your child sells the property 5 years later for $600,000, the tax picture looks like this: over 5 years they claim additional depreciation of 5 × $14,545 = $72,727. Their adjusted basis drops to $181,818 − $72,727 = $109,091. Total gain on sale: $600,000 − $109,091 = $490,909. Of that, $290,909 is unrecaptured Section 1250 gain ($218,182 you depreciated + $72,727 they depreciated), taxed at up to 25%. The remaining $200,000 is long-term capital gain.
Compare to inheritance: the step-up in basis difference
The most important comparison is between gifting now and letting the child inherit the property at your death. When a person inherits property, the beneficiary's basis is generally stepped up (or stepped down) to the property's fair market value on the date of death under IRC § 1014. This single rule permanently eliminates all deferred depreciation recapture and appreciation gain.
Using the same numbers: if your child had inherited the $550,000 property rather than received it as a gift, their basis would be $550,000 — not $181,818. They would begin a brand-new 27.5-year depreciation schedule on a $550,000 basis (allocable to the building), generating $20,000 of depreciation per year. After 5 years, their adjusted basis would be $550,000 − $100,000 = $450,000. A sale at $600,000 produces a gain of $150,000 — all long-term capital gain, none of it recapture from your years.
The difference between gifting and inheriting in this example: a $490,909 gain (with $290,909 of recapture) versus a $150,000 gain (zero recapture). For income-tax purposes alone, waiting to let the child inherit almost always wins. The gift makes sense only when estate-tax reduction, immediate income shifting, or non-tax factors override the income-tax cost.
Carryover basis and why the tax history travels with the gift
The carryover-basis rule under § 1015 means the gift is not a tax event for you — you recognize no gain at the time of the transfer. The taxable gain is deferred, not eliminated. It sits inside the property and will be recognized by whoever eventually sells it: your child, their heir, or a future buyer in a taxable transaction.
This is the opposite of a sale, which triggers immediate recognition of all gain and recapture. Gifting is attractive precisely because you do not pay tax on transfer — but that comes at the cost of handing the deferred tax bill to your child. It is a tax shift, not a tax elimination. Make sure your child understands this before the deed transfers, and give them your records so they can compute the eventual tax correctly.
Gift tax rules: Form 709, annual exclusion, and lifetime exemption
A gift of rental property does not trigger income tax to you at the time of the gift. It may, however, trigger gift tax reporting. The mechanics:
Annual exclusion: Each year you can give any individual up to the annual per-person exclusion (the amount is adjusted periodically for inflation — check IRS.gov or Rev. Proc. for the current year's figure) with no Form 709 filing required. Because real estate is typically worth far more than a single year's exclusion, a direct gift of an entire rental property almost always exceeds the exclusion.
Form 709: When a gift to a single individual exceeds the annual exclusion, you file Form 709 (United States Gift and Generation-Skipping Transfer Tax Return) by the due date of your personal income tax return for that year. Filing Form 709 reports the gift and reduces your available lifetime gift-and-estate exemption. Using lifetime exemption does not create an immediate out-of-pocket gift tax until the exemption is exhausted — which for most people it never is.
Gift splitting: If you are married, you and your spouse can elect to split the gift, treating it as if each of you gave half. Gift splitting effectively doubles the annual exclusion available for a single gift and spreads the lifetime exemption usage between both spouses.
Note that gift-tax rules are separate from income-tax rules. Using your lifetime exemption has no immediate income-tax cost; its effect is on your eventual estate tax, not your current income tax. For most families, the gift tax concern is secondary to the income-tax consequences of the carryover basis.
How your child's depreciation continues from your schedule
With a gift, the depreciation clock does not reset. Your child steps into your shoes and continues depreciating the property on your original schedule — they use your adjusted basis ($181,818 in the example) as their depreciable basis, and they have only your remaining recovery period (12.5 years) left to claim. They do not get a fresh 27.5-year schedule on the $550,000 fair market value.
This has two practical consequences. First, the annual depreciation deduction your child gets ($14,545 per year) is lower than they would get under a stepped-up basis ($20,000 per year under an inherited basis of $550,000). Second, every dollar of depreciation they claim further lowers their already-low adjusted basis, increasing both the gain on a future sale and the amount of that gain that qualifies as unrecaptured Section 1250 recapture.
The combination — low starting basis, limited depreciation going forward, and deferred recapture — makes inherited property materially more valuable on an after-tax basis than gifted property in most situations involving long-held, appreciated rentals.
Strategies to reduce the tax burden on the child
Installment-sale structure. If you want to transfer ownership to the child rather than give it outright, a seller-financed installment sale allows you to spread the gain and recapture recognition over multiple years under IRC § 453. The gain is recognized as payments are received rather than all in the year of sale. The child begins with the purchase price as their basis — not your carryover basis — so this avoids passing the built-in recapture to them. The tradeoff is that you owe income tax over time rather than never, but the tax hit is spread out and the child gets a clean basis.
Gradual gifting of fractional interests. Rather than gifting the entire property at once, some families gift small ownership interests annually, staying within the annual exclusion for each recipient. Over many years, the child accumulates a larger ownership stake with less gift-tax impact. This approach keeps the property in shared ownership for years and complicates management, but it can limit the exposure to any single year's gift-tax filing requirements.
Intentionally Defective Grantor Trust (IDGT). A more sophisticated approach used in estate planning is to sell the rental to an IDGT in exchange for a promissory note. The sale to the trust is income-tax free (because a grantor trust is ignored for income tax purposes), the note payments are not income to you, the trust gets a stepped-up basis at your death for estate-tax purposes, and the asset (and its future appreciation) is outside your estate. This strategy requires a qualified estate attorney and careful implementation.
Planning considerations before the deed transfers
Before signing over a rental to a child, work through four questions with a CPA or estate attorney:
What is the after-tax value the child actually receives? Subtract the estimated tax on the built-in gain from the fair market value. A $550,000 property with $290,909 of recapture at 25% and $200,000 of capital gain at 15% carries approximately $72,727 + $30,000 = $102,727 of embedded tax liability, reducing the after-tax value to roughly $447,000. Make sure the gift is as large as you think it is.
Is your estate large enough to face estate tax? If your estate comfortably stays below the applicable exemption, keeping the property until death to capture the step-up is almost always the better income-tax outcome. If your estate is large enough that estate tax is a real concern, gifting the property (and its future appreciation) out of your estate now may save more in estate tax than the lost step-up costs in income tax.
What tax bracket will your child be in when they sell? If your child is in a materially lower bracket, the recapture and capital gain they eventually pay may be taxed at lower rates than you would pay, making the income-shift worthwhile. Be aware that the 25% rate on unrecaptured Section 1250 gain is a ceiling that applies even to lower-bracket recipients, so the bracket benefit mainly accrues on the non-recapture capital gain portion.
Does the kiddie tax apply? If the child is under 19 (or under 24 and a full-time student), the kiddie tax under IRC § 1(g) taxes certain unearned income at the parents' rate. Rental income and gain from a gifted property held by a dependent minor or student may not be taxed at the child's low rate at all — it may be taxed at yours. The kiddie tax generally does not apply once the child is an independent adult with their own earned income exceeding half of their support.
Records to hand over with the deed
The gift is only complete and defensible if the recipient has the tax records they need to compute basis and gain when they eventually sell. Hand over:
- The original closing statement (HUD-1 or ALTA settlement statement) showing the purchase price and any closing costs added to basis.
- A list of all capital improvements, with dates, amounts, and receipts — improvements increase basis and reduce gain.
- Your complete depreciation schedule: every year's Form 4562, or a summary showing cost, prior depreciation claimed, and adjusted basis as of the gift date.
- The deed and title history, especially if there were any prior adjustments to basis (casualty losses, partial dispositions, etc.).
Without these records, your child cannot reconstruct the correct adjusted basis. Understating accumulated depreciation (and thus overstating basis) understates the recapture on a future sale — an error the IRS can assert years later. Overstating prior depreciation understates basis and overstates the gain, resulting in the child paying more tax than owed. Only accurate records produce the right number.
Frequently asked questions
Does gifting a rental to my child avoid depreciation recapture?
No. Your child inherits your adjusted basis — including all accumulated depreciation. When they sell, they owe unrecaptured Section 1250 tax on every dollar you depreciated, plus any additional depreciation they claim. The recapture transfers rather than disappears.
Does my child file a gift tax return?
No — you do. As the donor, you report gifts above the annual exclusion on Form 709 and the gift reduces your lifetime gift-and-estate exemption. Your child generally has no gift tax filing obligation.
Will my child start a fresh depreciation schedule after the gift?
No. With a gift, the recipient continues your existing depreciation schedule — same adjusted basis and same remaining recovery period. A fresh schedule starting at fair market value only applies to inherited property that receives a step-up in basis.
Is it better to let my child inherit the property instead of gifting it?
From a pure income-tax standpoint, often yes. Inherited property typically receives a step-up in basis to fair market value at the date of death, eliminating all deferred depreciation recapture. Gifting is better when removing the asset from your estate for estate-tax purposes, or when shifting current rental income to a lower-bracket child, is the primary goal.
What records should I give my child when I gift the property?
Provide your original purchase price, a list of all capital improvements with dates and amounts, and your complete depreciation schedule showing cumulative depreciation claimed (from your Form 4562 filings). Without these, your child cannot correctly calculate adjusted basis, gain, or the recapture portion when they eventually sell.
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.