Gifting a Rental Property to a Family Member

Transferring a rental property to a family member is a significant financial decision with specific tax and legal considerations distinct from gifting a personal residence. The transaction can be an effective way to pass on wealth, but it requires careful planning to navigate the rules and reporting requirements for both the giver and the recipient.

Tax Consequences for the Giver

When you gift a rental property, the primary tax consideration is the federal gift tax. The Internal Revenue Service (IRS) allows you to give a certain amount to any individual each year without tax consequences. For 2025, this annual gift tax exclusion is $19,000 per recipient. If the fair market value of the rental property exceeds this amount, you are required to report the gift to the IRS, though it does not automatically mean you will owe tax.

Any amount gifted above the annual exclusion is applied against your lifetime gift and estate tax exemption, which is $13.99 million per individual for 2025. For example, if you gift a rental property with a fair market value of $319,000, the first $19,000 is covered by the annual exclusion. The remaining $300,000 is the taxable portion of the gift, which then reduces your lifetime exemption. You would not pay an out-of-pocket gift tax unless your total lifetime gifts exceed this high threshold.

Another income tax consideration involves suspended passive activity losses. If your rental property generated tax losses that you were unable to deduct in prior years due to passive activity loss limitations, you cannot deduct these losses when you gift the property. Instead, these suspended losses are added to the property’s cost basis immediately before the transfer. This adjustment increases the basis for the recipient, which can reduce their future capital gains tax, but provides no immediate tax deduction for you, the donor.

Tax Consequences for the Recipient

For the family member receiving the property, the primary tax concept is the “carryover basis,” which means the recipient takes on the donor’s adjusted basis in the property. The donor’s adjusted basis is their original purchase price, plus capital improvements, minus the total depreciation deductions claimed during their ownership. This figure is the starting point for the recipient’s tax calculations.

The recipient also inherits the potential for depreciation recapture. The responsibility for depreciation passes from the donor to the recipient at the time of the gift. When the recipient later sells the property, they will be required to “recapture” the depreciation taken by both themselves and the original donor. This recaptured amount is taxed as ordinary income, not at the lower capital gains rate.

A special rule applies if the property’s fair market value (FMV) at the time of the gift is less than the donor’s adjusted basis. In this situation, the recipient has a dual basis. For calculating a gain on a future sale, the recipient uses the donor’s higher adjusted basis. For calculating a loss, the recipient must use the lower FMV at the time of the gift.

To illustrate, suppose a parent gifts a rental property with an adjusted basis of $200,000 but an FMV of only $150,000. If the child later sells the property for $220,000, they would use the $200,000 basis to calculate a $20,000 gain. If they sell it for $140,000, they must use the $150,000 FMV basis to calculate a $10,000 loss. If the sale price is between $150,000 and $200,000, no gain or loss is recognized.

The recipient’s holding period for the property is also affected. To determine long-term or short-term capital gains on a future sale, the recipient’s holding period includes the time the donor owned the property. This “tacking” of the holding period is beneficial, as it helps ensure that any future gain will be taxed at more favorable long-term capital gains rates.

Required Information and Documentation

Before the transfer, you must obtain a qualified appraisal of the rental property. This appraisal must be performed by an independent and certified appraiser to establish the property’s fair market value (FMV) on the date of the gift. This FMV is required for tax reporting and determines the value of the gift.

The legal transfer of ownership is accomplished through a new deed prepared to transfer the title from the donor to the recipient. This document requires the full legal names of both parties and the precise legal description of the property. Preparing and executing a deed is a legal process commonly handled by a real estate attorney or title company to ensure its validity.

If the property’s value exceeds the annual gift tax exclusion, the donor must file IRS Form 709, United States Gift Tax Return. This form reports the gift and tracks the use of the lifetime exemption. To complete Form 709, you will need:

• The donor’s and donee’s names, addresses, and Social Security numbers
• A description of the gifted property
• The property’s appraised FMV
• The donor’s adjusted basis

Executing the Property Transfer

The donor must sign the newly prepared deed in the presence of a notary public. The notary will verify the donor’s identity and witness the signature, then affix their official seal and signature to the document, a process known as notarization.

Once the deed is signed and notarized, it must be recorded with the appropriate government office, which is typically the county recorder’s or clerk’s office where the property is located. This step makes the transfer official public record, protecting the new owner’s rights to the property. There will be a nominal recording fee, which varies by location.

The final action is to submit the completed Form 709 to the IRS. This form cannot be filed electronically and must be mailed. The deadline for filing Form 709 is April 15 of the year following the year in which the gift was made, aligning with the income tax filing deadline. An extension to file your federal income tax return will automatically extend the time to file Form 709.