Real Estate transfers occur either by sale, trade, gift or at death. The income tax impact differs in each instance. I need to note at the onset that my Capital Transactions textbook at the University of Denver tax school was about 3 ½ inches thick. So, this summary is not intended as an exhaustive explanation of all tax considerations. It is only intended to identify the major distinctions between the four types of transfers.
Sale. The seller’s tax basis is the amount he paid for the property, plus capital improvements, less depreciation taken (if any). At sale, the taxable gain is the sales price, less costs of sale, less tax basis. The buyer’s basis is the amount he pays.
Trade. If real property is used for trade, business or investment, the owner can trade the property for “like kind” property that also is used for those purposes without recognizing gain. The tax basis in the new property is the same as the basis in the previous property–ie “substituted basis.” Known as a “tax free” or “Section 1031” exchange, the rules become complicated when cash is exchanged and debt forgiven.
Gift: When property is given (without payment) to someone during the donor’s lifetime, the tax basis to the donee is the same as that of the donor. The basis is “carried over.” A simple example: if a building lot was purchased by the donor for 3,000 and is worth $10,000 on the date of the gift, the donee’s basis is only $3,000.
Death: But when property is transferred at death, the basis is “stepped up” to the fair market value as of the date of death. Using the above example, if the decedent’s basis is $3,000 but worth $10,000 on his death, then the recipient’s basis is $10,000. Ie, the basis is “stepped up.”
While taxable gain in sale situations is pretty universally understood, the tax impact in trade, gift and death circumstances usually requires the attention of a tax advisor.