For wealthy families considering estate planning options, gifting a personal residence can appear attractive. After all, real estate doesn't generate income like liquid investments, and transferring property might seem easier than parting with assets that support your lifestyle. However, gifting residential real estate involves unique complexities and trade-offs that require careful evaluation.

The decision to gift a residence isn't just about removing an asset from your taxable estate. It involves navigating tax implications, family dynamics and practical considerations that don't apply to other asset classes. Understanding these factors is essential for making informed decisions about whether — and how — to transfer residential property to the next generation.

Why families consider gifting real estate

Beyond standard estate planning objectives, families are often motivated by specific goals when considering residential real estate transfers:

• Protecting family wealth: Gifting property in trust ensures the asset remains within the family bloodline, protected from creditors and marital dissolution. The grantor retains influence over how the property is used and managed across generations.
  
  
• Locking in gift and estate exemptions: Families may want to secure the benefits of today's historically high exemption amounts. A residence with significant value that the family anticipates will continue to appreciate can effectively transfer substantial wealth (and future appreciation) while utilizing available exemptions.
  
  
• Preserving family traditions: Whether it's a ski chalet for holiday gatherings or a beach house where grandchildren spend summers, families use trusts to perpetuate traditions and create lasting connections for future generations.

Strategic approaches to real estate gifting

The direct transfer: Outright gift

The simplest approach involves transferring title directly to an individual or trust. This works well when the grantor doesn't intend to continue using the property. However, it's crucial to ensure recipients can manage the property and cover ongoing expenses.

Advanced strategies: threading the needle

For families wanting to transfer property while maintaining some level of access, several sophisticated strategies exist:

Gift and lease back strategy. Transfer the property to family members or a trust, then lease it back at fair market rent. This allows continued residency while removing the asset from your taxable estate. The rental payments provide additional wealth transfer opportunities to the new owners.

Spousal Lifetime Access Trust (SLAT). Fund an irrevocable trust for your spouse's benefit with the residence. This addresses three key objectives: utilizing current exemptions, removing future appreciation from your estate and preserving indirect access through your spouse.

Qualified Personal Residence Trust (QPRT). Transfer the residence to an irrevocable trust while retaining the right to live there rent-free for a specified term. The gift value is discounted based on your retained occupancy rights, potentially creating substantial transfer-tax savings.

Drawbacks to gifting real estate

Loss of basis step-up

Perhaps the most important financial consideration is the loss of federal income tax basis adjustment at death. Appreciated property held individually receives an adjustment in basis (“step-up”) to fair market value upon the owner's death, potentially eliminating capital gains tax on appreciation. Gifted property retains the grantor's original basis, meaning eventual sale could trigger substantial capital gains taxation.

Federal gain exclusion impact

Homeowners can exclude up to $250,000 (single) or $500,000 (married) of capital gains when selling their primary residence, subject to ownership and use requirements. Transferring property to an irrevocable trust may affect this exclusion, though it may remain available if the trust qualifies as a grantor trust.

Financing and lending challenges

Gifting mortgaged property may trigger "due on disposition" clauses requiring immediate loan repayment. Additionally, lenders are often reluctant to issue new loans against trust-held property due to the lack of personal guarantees from living individuals.

State and local tax ramifications

Property transfers can trigger reassessment for local property tax purposes. In California, for example, Proposition 13 caps assessment growth, but ownership changes even for certain family transfers can cause significant tax increases. Florida's Homestead designation may be lost upon transfer to certain types of trusts, which may result in higher property taxes.

Creating sustainable family ownership

Successful real estate gifting extends beyond tax planning to include:

Funding future expenses: Trusts holding real estate need liquid assets to cover property taxes, insurance, maintenance and administration costs. Without adequate funding, beneficiaries may be forced to sell the property to meet obligations.

Establishing governance: When multiple family members will share property use, clear frameworks are essential, addressing:

•  Usage rights and scheduling
• Expense responsibilities and contributions
• Decision-making authority for improvements
• Circumstances and procedures for potential sale

The Merrill Center for Family Wealth^® offers detailed guidance on family vacation home governance in their report "Your Family, Your Vacation Home".

Making the right choice

Understand the trade-offs: immediate transfer tax savings versus future income tax consequences, family access versus legal control, or simplicity versus optimization. Each family's situation requires careful analysis of their specific objectives, risk tolerance and long-term plans.

Ready to evaluate whether gifting personal real estate aligns with your wealth transfer goals? Contact your Merrill Private Wealth Advisor to discuss strategies tailored to your family's unique circumstances.