Don’t Look a Gift Deed in the Mouth: Should I Gift My Property or Quitclaim?

With the holidays approaching, some people might be looking to transfer property from one individual to another, or simply to rearrange their portfolio. One of the more common questions we get is whether or not gifting a property is better compared to quitclaiming a property. In some situations, there are benefits to structuring your property transaction in a smart way that will benefit your portfolio or estate, and it all depends whether or not consideration is passing, and what device is used to convey the property. In some instances, when an individual gifts real property to another person, they might actually be gifting them a huge Capital Gains Tax bill as compared to if they structured the transfer in a different way. This decision is a strategic move that may involve a few key advisors, such as your attorney, financial planner, accountant, and estate planner.

Standard Property Transaction        

The person who is the legal owner of the real property who is giving it up in the transaction is called the Grantor. The person who is receiving the real property in the transaction is the Grantee. In most property transactions, the real property flows from Grantor to Grantee. In a standard property transaction, one person gives another person something of value in exchange for receiving legal title to a piece of real property. The “something of value” is called “consideration”. Consideration takes many forms, but the most common is usually money in the form of cash, cashier’s check, wired funds, etc. This is the most prevalent form of transaction you will encounter, and is most commonly associated with a residential home purchase. Commercial transactions also are of this same nature, where commercial property is bought either outright with cash, or through some other financing instrument. Consideration can also take other forms, such as other valuable pieces of personal property like appraised collectibles, securities, contracts of performance, and other quantifiable items where value can be attached (this can raise questions as to how the accurate value is determined, which is why most real property transactions use cash as the consideration).

 Usually between two private individuals where one person decides they want to give another person real property without receiving anything in return, this is commonly referred to as a “gift” and there are a few ways that this can be accomplished. Individuals who are enamored by each other, such as significant others, domestic partners, or spouses can give each other property “in consideration of love and/or mutual affection”, or individuals can simply gift property without expecting to receive anything in return. However, the law pays attention to the specific wording that is used in property transactions when determining how to classify the transaction for the purpose of taxation. Whereas giving property “in consideration of love and/or mutual affection” may be appropriate on a quitclaim deed and may qualify for an exemption to excise tax, it might not be appropriate for a gift deed, and there are different rules that may apply upon taxation.

Excise Tax vs. Capital Gains Tax

First, there are two important distinctions that we must understand. “Excise Tax” is the amount of tax due on the sale of real property which is dependent on the sale price of the real property, and in the State of Washington is calculated using a bracketed system. The Grantor and Grantee execute a Real Estate Excise Tax Affidavit where the sale price is listed, and for every bracket where the sales price is above a certain limit (for example, $0 - $525,000.01, $525,000.01 - $1,525,000, etc.) there is a different taxation rate within that bracket. In contrast, “Capital Gains Tax” is a tax levied on the amount of capital gain realized from the difference of a real property’s original cost basis to its purchase price. Washington-specific exemptions can apply to the Excise Tax, whereas Capital Gains Tax is both a state and federal taxation question.

Gifting Property

When property is gifted, federal rules regarding taxation may apply. Depending on how your estate is structured, the total gifted might need to be reported to the IRS. Federal taxation rules under the Internal Revenue Code dictate that anything of value given to another person constitutes a “gift” and should be reported as such. The same is true for real property. There are certain limitations on how much a person can gift over the course of a year and over the course of their lifetime without incurring significant taxes, and these questions are best suited to a tax attorney or a financial planner to determine if gifting real property is right for your situation. While some persons might see gifting as a generous way to show affection or to dispose of an asset, you might actually be gifting more debt that value due to the complex rules regarding taxation.

Real property for gifting purposes has two values that can be attached to it: the “cost basis” of the real property, and the “fair market value/purchase price” of the real property. The “cost basis” in simple terms is the value paid to acquire the real property, and the “fair market value/purchase price” is how much the real property is sold for later on down the line. Usually, real property appreciates/increases in value over time, so it is sold at a higher value in the future, and the difference is referred to as a “capital gain”. This is important for gifting purposes because how much capital gain is realized from the last time the cost basis is “adjusted” or “stepped-up” can really make a huge impact on how you choose how to distribute your property.

To best illustrate this, let’s say that Person A purchased a piece of real property in 1980 at an initial cost basis of $80,000. Person A holds onto the real property until 2025 where the value has appreciated to an astounding $1,600,000 (not fairly uncommon, especially if you purchased real estate in metropolitan areas like Seattle, Bellevue, or Redmond during 1980). Person A is looking to transfer ownership of the property to Person B, and initially thinks about gifting the property out of love and mutual affections, which is very generous of them at first glance. However, because of the large appreciation in value from 1980 to 2025 and since the method of transfer is a gift and the real property’s cost basis was never “stepped-up” (e.g. re-appreciated to a more current fair market value), the IRS will recognize a taxable capital gain of $1,520,000.

Fortunately for Person A and B, in most circumstances they will not need to pay tax on the $1,520,000 at the time of the gift transfer, so Person B, satisfying other requirements, will be able to take title to the property. Unfortunately for Person B, when they go to sell the property, that’s when they will owe the Capital Gains Tax. With Capital Gains Tax percentages at up to 20%, Person B might owe up to $304,000 on the sale, which may be a huge problem if they are unable to afford the tax bill. So, while Person A might have been gifting the real property as a sign of good will or affection, in reality, what was gifted was a massive tax bill headache. Not to mention there may be additional state taxes due and owing on the transaction.

Quitclaim

A Quitclaim deed is a type of deed where an individual agrees to give up whatever ownership interest they may have in a piece of property, if any, with no warranties whatsoever, in exchange for some form of consideration. Quitclaim deeds are useful devices for simple property transactions and clearing title. In the above-referenced example, if Person A had quitclaimed the property to Person B under the same facts, could they have avoided paying the Capital Gains Tax? Not necessarily. A quitclaim deed is another legal device to transfer property. However, in certain transactions where a genuine exemption can be found under the Washington Administrative Code, individuals might qualify for an exemption to the Excise Tax. Quitclaim deeds are often used to solve unique problems when transferring real estate. An exemption to the Excise Tax exists for gifting property, provided that no form of consideration passes otherwise. There are also exceptions for establishing community property, bankruptcy, clearing title, re-recordings, and mere changes in identity.

If gifting a property or quitclaiming does not result in an adjustment in cost basis, then which actions would result in an adjustment in cost basis? Usually, when property is purchased rather than gifted, it receives a step-up in cost-basis. So, assume that in the above-referenced example that instead, Person A sells the property to Person B and pays Person A the tax bill, compared to gifting the property. Person B’s cost basis would be the $1,600,000 paid to purchase the property. That way, when Person B sells to Person C at a price of $2,000,000, only $400,000 of capital gain is realized, and if there is a maximum of 20% of Capital Gains Tax levied on Person B, he would owe only up to $80,000, representing a significant decrease in tax liability.

Distributing via Will or Trust

One other way that real property may receive a step-up in basis is if property is inherited via a will or distributed through a trust. If Person A owned the real property described above in 2025 and instead died and distributed it to Person B through their will, under certain provisions in the Internal Revenue Code the real property would receive a “step-up” re-evaluation in cost basis to the fair market value of $1,600,000. This would mean that when Person B goes to sell to Person C for $2,000,000, only $400,00 of capital gain would be realized instead of $1,920,000 had the piece of property not received a step-up in cost basis. This could mean the difference between receiving a property with a negligible tax bill, or an immense headache. The same principle can apply to the distribution of property out of a trust at the time of the death of the grantor, which is when the step-up in basis occurs. So, if Person A creates the Person A Revocable Living Trust, transfers the property into the trust, names Person B as the beneficiary, and stipulates to have the property distributed out of the trust upon Person A’s death, the property will receive a step-up in basis at that time. This is why estate planning with your estate attorney and financial planner is so important to make sure that assets are distributed ahead of time, because like the old adage says, “if you don’t have an estate plan, the State has one for you.”

Conclusion

There are different ways to convey property as a sign of good will and affection, but just because there are different ways doesn’t mean that each way will be the best way for your specific situation. The conveyance of real property is an important decision that should be thought of thoroughly and with the help of qualified experts ranging from your legal counsel to your financial and estate planners. Structuring your property transfer in a way other than a gift can help the recipient either mitigate or avoid Excise or Capital Gains Taxes in a legal and permissible manner. That is why it is important to start planning the transfer now and to talk to a qualified legal professional to see how they can assist you with your property transfer. Give the gift of property ownership this holiday season, not unmanageable tax burdens.