Gift of Equity Rules: Tax, Basis, and Medicaid Look-Back

A gift of equity has tax consequences on both sides of the closing table. The seller usually has to file a federal gift tax return and may also owe capital gains on the sale portion. The buyer takes the home with a reduced cost basis, which can mean a larger taxable gain whenever they eventually sell. For 2026, the figures that drive the math are a $19,000 annual gift tax exclusion and a $15 million lifetime gift and estate tax exemption per person.¹

What Counts as the Gift

The gift of equity is the gap between the home’s appraised fair market value and the price the buyer actually pays. A home that appraises at $400,000 and sells to a family member for $350,000 carries a $50,000 gift of equity, which appears on the closing disclosure as a credit to the buyer.² The lender orders an independent appraisal to fix fair market value, and that appraised figure is the number the IRS will work from too. Every tax calculation that follows anchors to it.

Gift Tax Rules for the Seller

Federal gift tax falls on the seller, not the buyer. The 2026 annual exclusion lets any individual give any other individual up to $19,000 without filing anything.³ Most gifts of equity run well above that, so the seller almost always has to file.

Anything above $19,000 chips away at the seller’s lifetime gift and estate tax exemption, which Congress permanently set at $15 million per individual in the One, Big, Beautiful Bill Act signed in July 2025. The exemption begins adjusting for inflation in 2027.⁴ On a $50,000 gift of equity, the first $19,000 is excluded and the remaining $31,000 reduces the lifetime cap. No tax actually comes due unless the seller has already given away more than $15 million over their lifetime. Above that line, the gift tax rate reaches 40%.⁵

Gift Splitting for Married Sellers

A married couple can elect to split the gift and combine their annual exclusions, lifting the per-recipient threshold to $38,000. On that same $50,000 gift of equity, splitting trims the amount applied against the lifetime exemption from $31,000 to $12,000. Both spouses have to file Form 709 for the year, even if only one of them owned the property.³

Filing Form 709

Form 709 is due April 15 of the year after the gift is made. Filing is mandatory any time the gift exceeds the annual exclusion, even when no tax is owed, because the form tracks the running total against the lifetime cap.³ Extending your income tax return gives you an automatic six-month extension on Form 709. If you aren’t extending the income tax return, Form 8892 handles the gift tax extension on its own. Either way, the extension buys time to file, not time to pay.⁶

Capital Gains on the Seller’s Side

The gift return isn’t necessarily the only form the seller has to think about. The IRS treats a below-market sale meant as a gift as a “bargain sale,” splitting the transaction into a sale piece and a gift piece.⁷ When the sale price exceeds the seller’s adjusted basis, the difference is a taxable gain, completely separate from the gift of equity itself.

Say a parent bought the home decades ago for $200,000 and sells to their child for $350,000, with the home appraising at $400,000. The parent has a $150,000 capital gain on the sale and a $50,000 gift of equity on top.

Most families owe nothing on that gain. If the home was the seller’s primary residence and they lived there at least two of the five years before the sale, the Section 121 exclusion shelters up to $250,000 of gain for single filers and $500,000 for married couples filing jointly.⁸ That wipes out the gain in most family gift-of-equity sales.

One rule to know: if the seller’s basis happens to come in above the sale price, they cannot claim the loss. Losses on bargain sales intended as gifts are specifically disallowed.⁷

What the Buyer Inherits: A Lower Cost Basis

The buyer’s cost basis is the long-tail tax issue in these deals, and it’s the one most families overlook at closing. Because the buyer pays something but also receives a partial gift, Treasury regulations treat the transaction as part-sale, part-gift. The buyer’s basis is the greater of:⁹

the amount the buyer actually paid, or
the seller’s adjusted basis at the time of transfer.

In most family deals the buyer’s purchase price easily exceeds the seller’s old basis, because the seller bought years or decades ago at much lower prices. So the buyer’s basis usually equals what they paid. If the seller acquired the property recently or sank significant money into improvements and their adjusted basis runs higher than the sale price, the buyer picks up that higher basis instead.

How the Lower Basis Shows Up at Resale

Use the same $400,000 home sold for $350,000, with the seller’s original basis at $200,000. The buyer’s basis is $350,000, the greater of what they paid and the seller’s basis.⁹ If the buyer later sells for $600,000, their taxable gain is $250,000. Had they bought at full market value, the gain would have been $200,000. The gift of equity effectively hands the buyer an extra $50,000 of future taxable gain.

Section 121 can cushion that too. A buyer who uses the home as a primary residence for at least two of the five years before selling can exclude up to $250,000 of gain, or $500,000 if married filing jointly.⁸ For properties that appreciate sharply or get converted to rental use, the depressed basis can still mean a noticeably bigger tax bill when the time comes.

When Gift Tax Is Actually Paid

If the seller has already burned through the $15 million lifetime exemption and actually pays gift tax on the transfer, the buyer gets an upward basis adjustment proportional to the property’s net appreciation relative to the total gift.¹⁰ The bump can’t push basis above fair market value at the time of the gift.¹¹ It’s a rare scenario, but worth knowing for families with estates above $15 million.

A Non-Tax Cost Worth Flagging: Medicaid Look-Back

If the seller might need Medicaid-funded nursing home care within five years, the gift piece of the transaction can create an eligibility problem that dwarfs any tax question. Medicaid’s look-back period reviews asset transfers made during the 60 months before an application for long-term care benefits, and selling a home below fair market value counts as an uncompensated transfer for the gift amount.¹²

The penalty is a period of Medicaid ineligibility. Each state divides the uncompensated gift by its average monthly cost of nursing home care to calculate the delay. A $50,000 gift of equity in a state where nursing care averages $10,000 a month works out to roughly five months with no Medicaid coverage. There is no cap on how long the penalty can run for larger gifts. Transfers to a spouse, a disabled child, or an adult child who served as a live-in caregiver for at least two years before the seller entered a nursing facility are generally exempt, but a standard sale to an adult child who wasn’t a caregiver is not. For sellers over 60 or in declining health, this is a conversation to have with an elder law attorney before signing anything.

1
Internal Revenue Service. What’s New – Estate and Gift Tax
2
Fannie Mae. B3-4.3-05, Gifts of Equity
3
Internal Revenue Service. Gifts and Inheritances
4
Office of the Law Revision Counsel. 26 USC 2010 – Unified Credit Against Estate Tax
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Office of the Law Revision Counsel. 26 USC 2502 – Rate of Tax
6
eCFR. 26 CFR 25.6081-1 – Automatic Extension of Time for Filing Gift Tax Returns
7
Internal Revenue Service. Publication 544 – Sales and Other Dispositions of Assets
8
Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence
9
eCFR. 26 CFR 1.1015-4 – Transfers in Part a Gift and in Part a Sale
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eCFR. 26 CFR 1.1015-5 – Increased Basis for Gift Tax Paid
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Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust
12
Centers for Medicare and Medicaid Services. Transfer of Assets in the Medicaid Program