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Imagine you have $50,000 to give to your daughter and her husband as a down payment on their new home. The question is: do you owe gift tax because of your generous gesture?
Despite popular belief, the federal gift and estate tax only applies to very wealthy households. Unless you have about $13 million to give away during your lifetime, these taxes probably don’t apply to you.
A financial advisor can help you navigate and plan for gift and estate taxes. Find an advisor today.
To be clear, these are the rules for federal taxation. Each state also has its own tax laws and every tax profile is different, so be sure to speak with a financial or tax professional before making plans for your home equity. However, there are two important issues to consider in this scenario: the mortgage process and the potential gift tax implications.
Deposits and gifts
With the mortgage and lender process, you want to be sure that you complete all forms and requirements correctly. It is extremely unlikely that you can complicate the title to this property, but you can certainly complicate or void the loan by making a mistake.
When your daughter applies for her mortgage, the lender will go through her finances in detail. They want to know what assets she has, where they come from, what income she has, and any other information regarding how she will repay this debt. The deposit is intended as an indicator of this financial stability, so receiving it from a third party may raise concerns.
Many lenders have rules about who can provide the money for a down payment. It’s common for them to deny a mortgage with a down payment unless that money comes from someone with a long-term relationship with the borrower. This is, among other things, intended to prevent fraud and money laundering. Since the borrower is your daughter, that shouldn’t be a problem.
If you give the money directly to your daughter, you will usually need to season the money or provide a gift letter. Seasoning the money means transferring it more than 60 days in advance, again as an indicator of legitimacy against fraudulent transfers. A gift letter is a document signed by both the giver and the recipient confirming that it is a unilateral transfer, with no right of refund.
The specific format of the gift letter varies depending on the lender and jurisdiction. Therefore, consult an attorney about this document. A financial advisor may also be able to help you with this process.
You can also make this transfer through the loan process, where you make the deposit on behalf of your daughter instead of transferring the money to her. The lender will require you and your daughter to disclose this during the loan application process. By itself, your donation usually won’t pose a problem, but if you don’t specify the difference between borrower and payer, it will almost always complicate (if not void) the loan.
Gift tax exclusions and exemption limits
Aside from the rules that apply to these types of donations, your main consideration here is gift tax.
This is a tax that the IRS levies on unilateral transfers. If you give someone money or property without expecting fair compensation, you have given him or her a gift. If you give them enough money, you (the donor) will ultimately have to pay taxes on the transfer. Gift tax rates range from 18% to 40%, depending on the size of the gift.
However, the gift tax only applies to very few households due to a few key tax provisions: an annual exclusion and a lifetime exemption limit. And if you have any questions about this, consider talking to a financial advisor.
Annual exclusion
The first is the annual gift tax exclusion. This is the amount of money you can give to someone each year, regardless of gifts in previous or future years. In 2023, the annual exclusion will be set at $17,000 for individuals and $34,000 for married couples filing their taxes jointly. By 2024, those limits will increase to $18,000 for individuals and $36,000 for married couples.
The annual exclusion applies per recipient. For example, suppose you had four children. You could give each of them $17,000 in 2023 without incurring any gift taxes.
Lifetime exemption
The lifetime exemption from gift and inheritance taxes is the amount of money you can give away over the course of your life (or upon your death) without being charged gift or inheritance taxes. For donations that exceed the annual exclusion, the difference will be applied to your lifetime exemption. If you give someone a gift during that year’s annual exclusion and have used up your lifetime exemption, you will owe gift taxes on the amount of money that exceeds that year’s exclusion.
In 2023, the lifetime exemption from gift and estate taxes will be $12.92 million for individuals, meaning married couples have a combined exemption limit of $25.84 million. In 2024, the exemption will increase to $13.61 million for individuals and $27.22 million for married couples. If an individual has already donated $12.92 million above the exclusion limits in 2023, he or she can donate an additional $690,000 in 2024 (excluding the annual exclusion amount).
Unlike the annual exclusion, the lifetime exemption does not reset. Although you can donate up to the annual exclusion each year, if you have any remainder left, your lifetime limit will be permanently reduced. The lifetime exemption applies per donor, which means that it applies collectively to all gifts you have given. For example, suppose you give $20,000 to each of your four children in 2023. Each gift exceeds the exclusion by $3,000. Collectively, they would reduce your lifetime exemption from gift and estate taxes by $12,000.
Gift taxes and down payments
When it comes to your daughter’s down payment, the tax issues are: Are you married? And how much have you given away throughout your life? For simplicity’s sake, let’s assume you’re single.
First, if you give her the down payment money in 2023, the first $17,000 of the gift is automatically free of any tax liability. However, because the gift exceeds the annual exclusion by $33,000, that remainder will reduce your lifetime exemption.
For example, if you have never given anyone a taxable gift, you will pay no gift tax and your annual exclusion will be reduced to $12.887 million ($12.92 million minus $33,000). If you’ve already used up your lifetime exemption, you’ll have to pay taxes on the $33,000.
However, there would still be ways to manage this potential tax liability. If you could wait until 2024 to give your daughter the money, your lifetime exemption would increase to $13.61 million. You can use the remainder for the new raised ceiling. You do not owe tax on the excess donation. But if you need extra help managing your tax obligations, consider working with a financial advisor.
In short
Unless you’ve gifted more than $12.92 million during your lifetime, you can almost certainly make a $50,000 down payment to your daughter or other family member and not have to pay any gift taxes in 2023. Just make sure you do the paperwork right, otherwise it can get more complicated. the loan.
Gift tax tips
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Will the fact that this is your daughter complicate things? Although the IRS does not treat gifts from parents differently, large gifts within a wealthy family can potentially complicate future planning around trusts and estates.
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A financial advisor can help you strategically give away assets to reduce your potential estate taxes. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free introductory meeting with your advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
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