If you have already gifted your home or other real estate to your child during your lifetime, you likely did so with the best intentions: to help them, avoid probate, or make the transition smoother. But you may now realize that the gift could cost your child significantly in capital gains taxes due to the loss of the step-up in basis.
The good news? Depending on your situation, it may not be too late to reverse the gift and take back ownership, which could allow your child to benefit from a step-up in basis when the property is inherited after your passing.
Here’s what you need to know…
What is the “Step-Up in Basis”
When you give capital assets, including real property, during your lifetime, your child receives your original cost basis (what you paid for the property). But if your child inherits it after your death, the cost basis “steps up” to the property’s fair market value at the time of your death. This effectively eliminates all of the accumulated gain on the property during your lifetime and significantly reduces, possibly even entirely eliminates, potential capital gains taxes if they sell the property.
For example: You bought your home for $300,000 (your cost basis) and it’s now worth $1,000,000. If you gift your home to your child, your child will receive the $1,000,000 home with your $300,000 cost basis. If your child sells the property for $1,000,000, your child must pay capital gains tax on the $700,000 difference. With federal long-term capital gains rates as high as 20% and with California capital gains rates equivalent to regular income tax rates, on $700,000 of gains, your child could pay over $200,000 in avoidable taxes.
However, if your child inherits that same $1,000,000 home from you when you pass away, your $300,000 cost basis steps up to $1,000,000, the fair market value on your date of death. If your child sells it for that same value or less, there’s no capital gains tax owed. Your child would only pay capital gains on any gains received in excess of $1,000,000, if your child sells the property for more than $1,000,000.
Can You Reverse a Real Property Gift?
In some cases, yes — but it depends on how the gift was structured. Here are the most common scenarios:
Scenario 1: If You Used a Revocable Trust or Retained Some Control
If you transferred the property into a revocable living trust with your child as a future beneficiary (not an outright gift), you likely still own the property for tax purposes. In this case, no reversal is needed and the step-up in basis can still apply. Please consider reviewing your estate plan and trust documents with an estate planning attorney to confirm.
Scenario 2: If You Executed a Deed Transfer (Outright Gift)
If you signed a grant deed or quitclaim deed transferring full ownership of your real property to your child, the IRS will likely consider the gift complete. This means that your child has already received your original cost basis. This is more difficult to undo, but generally possible.
To fix this situation, your child will need to consent to transfer the real property back to you via a deed. Essentially, your child would “gift” the real property back to you. This is typically allowed unless your child is under duress (e.g., legal judgments, divorce, bankruptcy). You must legally retitle the property in your name and document that the original transfer was not intended to be permanent.
Please note, the IRS may view a transfer-back as a sham if it’s too close to your date of death. Also, property tax reassessment could be triggered, especially under California’s Proposition Finally, you will likely need to file a Form 709 gift tax return with the IRS to report the gift for estate tax purposes.
Scenario 3: If You No Longer Have Control or Your Child Won’t Return the Property
Unfortunately, if your child has sold the property, encumbered it, or refuses to return it, it may be too late to reverse the gift. However, there may still be options for estate equalization or gifting cash or other assets through estate planning.
We strongly recommend that you immediately consult an experienced estate planning attorney who can discuss your options with you. The sooner you act, the better your chances of correcting the gift and restoring the tax advantages, particularly if your health is declining. A properly executed reversal and estate plan needs to be done well in advance to withstand scrutiny.
Final Things to Consider
Gifting property while you’re alive can feel generous, but in many cases, it comes at a major tax cost. If you’ve already made that gift, it’s not necessarily too late to fix it. Reversing the transfer, with your child’s cooperation, may preserve their ability to receive a stepped-up basis and avoid a significant tax burden while offering you financial security and control.
You’ve worked hard for your property. Let’s make sure it benefits your loved ones and you in the way you intended.
