Gifting Property to Your Children: Tax & Legal Considerations

The impulse is generous and understandable. A parent who has owned a Monterey Peninsula home for decades wants to see their children enjoy it, wants to simplify the estate while they are alive to explain their intentions, and wants to give rather than make their children wait.

What most parents do not realize before making this decision is that a gift of real property transfers the tax problem along with the property. The child who receives a Monterey Peninsula home as a lifetime gift inherits not only the home but the parent's original cost basis, which means they inherit the accumulated capital gain as well. Depending on how long the parent has owned the property and how much it has appreciated, that inherited tax liability can be substantial.

Understanding the difference between gifting during lifetime and transferring at death, and what Proposition 19 changed about both, is essential before any decision is made. This post explains all three dimensions.

 

The Lifetime Gift vs. Inheritance at Death

When a parent gifts real property during their lifetime, the recipient takes what is called the carryover basis. The child's cost basis for tax purposes becomes the parent's adjusted cost basis, not the current market value of the property. If the parent purchased the home in 1988 for $350,000 and the home is now worth $2.5 million, the child who receives it as a gift takes a $350,000 basis. If the child later sells the property, the capital gain is calculated from $350,000, producing an exposure of approximately $2.15 million before any exclusions.

The inheritance path works differently. When a property passes to a child at the parent's death rather than as a lifetime gift, the child receives a stepped-up basis equal to the fair market value of the property at the date of death. If the property is worth $2.5 million when the parent passes, the child's basis is $2.5 million. If the child sells it at that price or close to it, the taxable gain is minimal or zero.

On a Monterey Peninsula property with decades of appreciation, the difference in capital gains exposure between these two paths can exceed $500,000 in combined federal and California tax. That difference is not a technicality. It is the most important financial variable in this decision, and it changes the calculus for most families who work through it carefully.

The most generous thing a parent can do with an appreciated property is often not to give it away during their lifetime.

A CPA who models both paths for the parent's specific property and the children's specific tax situation is the right resource for this analysis. The difference in outcome between the two paths is large enough that the conversation is worth having before any other decision is made.

Capital gains rates and exclusion amounts are subject to change. Verify current federal and California rates with a CPA before making any transfer decision.

 

What Proposition 19 Changed About Parent-to-Child Transfers

Before Proposition 19 took effect in February 2021, California's parent-to-child exclusion allowed children who inherited a property to also inherit the parent's property tax assessed value, regardless of whether they moved in. A parent who purchased a Carmel home in 1975 with an assessed value of $180,000 could pass it to their child, who could then hold it as a rental or second home while continuing to pay property taxes based on that original $180,000 assessment. The tax savings over time were substantial.

Proposition 19 eliminated that benefit for properties that the child does not use as their primary residence. Under current law, a child who inherits a property and does not establish it as their primary residence within one year of the transfer loses the property tax basis transfer. The assessed value is reset to the current market value at the time of transfer.

On a Monterey Peninsula property with a low historical assessed value, this reset can represent a significant ongoing cost. A property currently assessed at $300,000 but worth $2.5 million, transferred to a child who plans to use it as a second home or rent it, will be reassessed to $2.5 million. At Monterey County's effective tax rate of approximately 1.1 to 1.2 percent, that reassessment adds roughly $24,000 to $26,000 per year in property taxes compared to what the parent was paying.

Parents who are planning to pass a Monterey Peninsula property to children who will not occupy it as a primary residence need to factor this ongoing cost into the planning conversation. The property tax benefit that once made parent-to-child transfers attractive for investment properties and second homes no longer exists in the same form.

Proposition 19 provisions apply to transfers occurring after February 16, 2021. The rules for primary residence transfers differ from those for non-primary transfers. An estate attorney can confirm how Prop 19 applies to a specific property and intended use.

 

Gift Tax: What It Means

Gifting real property during a parent's lifetime is subject to federal gift tax rules. The annual gift tax exclusion in 2025 is $18,000 per recipient. A Monterey Peninsula property worth $2.5 million vastly exceeds this annual exclusion, which means the gift requires filing a federal gift tax return on Form 709 for the year the transfer occurs.

Filing a gift tax return does not automatically mean paying gift tax. The excess above the annual exclusion counts against the donor's lifetime federal estate and gift tax exemption, which is $13.61 million per individual. For most Monterey Peninsula homeowners, a gift of the property will reduce the available lifetime exemption but will not produce an immediate out-of-pocket federal gift tax payment, because the combined value of the estate and the gift remains below the exemption threshold.

The significant caveat: the current federal lifetime exemption may revert to a substantially lower level after 2025 if Congress does not act to extend it. A parent whose total estate value, including the gifted property, approaches or exceeds the post-sunset exemption level may be creating an estate tax problem while trying to avoid a capital gains problem. These variables interact, and the only way to model them correctly is with a CPA who knows the complete picture.

California does not have a state gift tax or estate tax, which simplifies one dimension of the analysis. The federal picture is where the complexity lives.

The federal lifetime gift and estate tax exemption is scheduled to change. Verify current figures and the legislative status of the sunset provision with a CPA before initiating any transfer.

 

The Conversation Before the Decision

A parent who wants to pass a Monterey Peninsula property to their children deserves a complete picture of both paths before making a decision that may be difficult or impossible to reverse. The lifetime gift path and the inheritance-at-death path produce meaningfully different tax outcomes for the children, and Proposition 19 has changed the property tax calculation for non-occupying heirs in ways that were not in effect just a few years ago.

The Ruiz Group is not a tax advisor, and this decision requires professionals who are. What The Ruiz Group can do is connect parents and families with the CPAs and estate attorneys on the Monterey Peninsula who do this analysis well and who understand the specific financial dynamics of high-value coastal real estate. That conversation should happen before any transfer documents are prepared. The cost of a professional consultation is small compared to the cost of making the wrong choice.

 

Related reading: Understanding the Stepped-Up Basis  ·  Tax Basis Transfers: What Prop 19 Means for Monterey County Homeowners  ·  The Estate Planning Conversation Every Homeowner Should Have Before They List  ·  What Happens to a Monterey Peninsula Home When Both Owners Pass