Capital gains strategy: transferring gifted

The property was gifted to the daughter several years ago when her children were young. Since then, the home has appreciated significantly in value. The daughter now faces a decision regarding the financial and practical implications of transferring the asset back to her mother while she is still living. The property is described as very old and requiring significant ongoing maintenance. The daughter's total annual costs to maintain the property are approximately $20,000 to $25,000. With her spouse recently passing away, she is increasingly concerned about her ability to manage the property and its expenses alone.

Tax and estate-planning considerations

The daughter is specifically wondering whether transferring the property back to her mother's estate would allow it to receive a step-up in basis at the time of her mother's death. She is also aware of the potential for capital gains in the mid-six figures if she were to sell the property. The daughter's mother is in her 90s and may have another five to six years of life. This timeframe influences her consideration of whether to hold the property until her mother's death or pursue a transfer.

Potential consequences and professional guidance

Transferring the property back would be treated as a gift for federal tax purposes. There are gift-tax, capital-gains, Medicaid, estate-tax, and other consequences the daughter should be aware of if she proceeds with a transfer. The daughter acknowledges she likely needs to discuss this option with an estate-planning attorney and a CPA who understand both real estate and estate taxation before making a decision.

The fact that the mother gave the daughter the property does not, in itself, prevent the daughter from transferring it back to her mother and receiving a step-up in basis when the mother dies. The original gift and the act of "regifting" are treated as two separate transactions for tax purposes. However, there is an important exception: Section 1014(e) can prevent a step-up when property is transferred to someone who dies within one year and the property again passes back to the original donor. If the mother gave the daughter the house in 2016 and the daughter transfers it back in 2026, the fact that 10 years have passed does not by itself prevent a future step-up. There is also a special rule that can allow a surviving spouse to use the $500,000 home-sale exclusion for a sale occurring within two years after their spouse's death, provided all requirements are met. If her adjusted basis was $200,000 and she sold the home for $800,000, her capital gain would be based on that $200,000 basis. However, if she has lived there for at least two of the five years before selling, she may qualify for the federal home-sale exclusion. That exclusion can shelter up to $250,000 of gain, or up to $500,000 for married couples filing jointly.