Imagine you have $50,000 to give to your daughter and her husband for a down payment on their new home. The question is, will you owe gift taxes because of your generous gesture?
Despite popular framing, the federal gift and estate taxes only apply to very wealthy households. Unless you have approximately $13 million to give away over your lifetime, these taxes likely won’t apply to you.
A financial advisor can help you navigate and plan for gift and estate taxes. Find an advisor today.
To be very clear, these are the rules for federal taxation. Every state also has its own tax laws and every tax profile is different, so make sure to speak with a financial or tax professional before making any plans for your own assets. However, there are two main issues to consider within this scenario: the mortgage process and potential gift tax implications.
Down Payments and Gifts
With the mortgage and lender process, you want to ensure that you fill out all forms and requirements correctly. It is extremely unlikely that you can complicate the title to this property, but you can certainly complicate or invalidate 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 came from, what income she has and any other information related to how she will repay this debt. The down payment is intended as an indicator of this financial stability, so receiving it from a third party can raise concerns.
Many lenders have rules around who can provide the money for a down payment. It’s common for them to reject a mortgage with a gifted down payment unless that money comes from someone with a longstanding relationship to the borrower. Among other issues, this is intended to prevent fraud and money laundering. Since the borrower is your daughter, that shouldn’t be a problem.
If you are giving the money directly to your daughter you will typically either 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 this is a unilateral transfer with no right to repayment.
The specific format of the gift letter will vary based on lender and jurisdiction, so consult an attorney about this document. A financial advisor can also potentially help you through this process.
You may also make this transfer through the loan process, making the down payment on your daughter’s behalf rather than transferring the money to her. The lender will require you and your daughter to disclose this during the loan application process. In and of itself, your gift will typically not be a problem, but failing to specify the difference between borrower and payer will almost always complicate (if not invalidate) the loan.
Gift Tax Exclusions and Exemption Limits
Beyond the rules that surround making a gift of this sort, your main consideration here is the gift tax.
This is a tax that the IRS places on unilateral transfers. If you give someone money or assets without expecting fair-value compensation in return, you have given them a gift. If you give them enough money, eventually you (the gift giver) must pay taxes on the transfer. Gift tax rates range from 18% to 40% based on the size of the gift.
However, the gift tax only applies to very few households due to a pair of important tax provisions: an annual exclusion and a lifetime exemption limit. And if you have additional questions about either, consider speaking with a financial advisor.
The first is the gift tax’s annual exclusion. This is the amount of money you can give to someone each year regardless of gifts in past or future years. In 2023, the annual exclusion is set at $17,000 for individuals and $34,000 for married couples who file their taxes jointly. In 2024, those limits will increase to $18,000 for individuals and $36,000 for married couples.
The annual exclusion applies on a per-recipient basis. So, for example, say that you had four children. You could give each of them $17,000 in 2023 without triggering any gift taxes.
The lifetime gift and estate tax exemption is the amount of money you can give away over the course of your life – or at your death – without triggering either gift or estate taxes. For gifts that exceed the annual exclusion, the difference is applied to your lifetime exemption. If you give someone a gift over that year’s annual exclusion and have exhausted your lifetime exemption, you’ll owe gift taxes on the amount of money that exceeds that year’s exclusion.
In 2023, the lifetime gift and estate tax exemption is $12.92 million for individuals, which means 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 gifted $12.92 million over the exclusion limits by 2023, they will be able to gift another $690,000 in 2024 (not including the annual exclusion amount).
Unlike the annual exclusion, the lifetime exemption does not reset. While you can gift up to the annual exclusion each year, any remainder permanently reduces your lifetime cap. The lifetime exemption is on a per-donor basis, meaning that it applies collectively to all gifts you have given. For example, say that in 2023 you give $20,000 to each of your four children. Each gift exceeds the exclusion by $3,000. Collectively, they would lower your lifetime gift and estate tax exemption by $12,000.
Gift Taxes And Down Payments
When it comes to your daughter’s down payment, the tax issues are this: Are you married? And how much have you given away throughout your life? Let’s assume you’re single for simplicity’s sake.
First, if you give her the down payment money in 2023, the first $17,000 of the gift will automatically be free of any potential tax liability. However, since the gift exceeds the annual exclusion by $33,000, that remainder will lower your lifetime exemption.
So, 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 have already exhausted your lifetime exemption, you would 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 go up to $13.61 million. You can apply the remainder to the newly raised cap and will owe no taxes on the excess gift. But if you need additional help managing your tax liability, consider working with a financial advisor.
Unless you have gifted more than $12.92 million over your lifetime, you can almost certainly give a $50,000 down payment to your daughter or other family member and not owe gift taxes in 2023. Just be careful to do the paperwork right, otherwise, it could complicate the loan.
Gift Tax Tips
- Will the fact that this is your daughter complicate things? While the IRS does not treat gifts from parents differently, large gifts within a wealthy family can potentially complicate future planning around trusts and estates.
- A financial advisor can help you strategically give away assets to lower your potential estate tax liability. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel 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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