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

The tax implications of a gift of equity fall on both sides of the closing table: the seller generally has to file a gift tax return and may owe capital gains on the portion they actually sold, while the buyer takes a lower cost basis that can enlarge their taxable gain when they eventually sell. For 2026, the numbers driving these outcomes are a $19,000 annual gift tax exclusion and a $15 million lifetime gift and estate tax exemption per individual.¹

What Counts as the Gift

The gift equals the gap between the 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, shown on the closing disclosure as a credit to the buyer.²

The lender orders an independent appraisal to fix that fair market value. Treat the appraised figure as the anchor for every tax calculation that follows, because the IRS will too.

Gift Tax on the Seller’s Side

All federal gift tax obligations sit with the seller. The 2026 annual exclusion lets any individual give up to $19,000 to any other individual with no reporting required.³ Most gifts of equity clear that number easily, so a return is usually required.

Anything above the annual exclusion draws down the lifetime gift and estate tax exemption. That exemption is $15 million per individual for 2026, permanently raised by the One, Big, Beautiful Bill Act signed in July 2025, and set to adjust for inflation starting in 2027.¹⁴

Work through the $50,000 example. The first $19,000 is excluded. The remaining $31,000 is subtracted from the seller’s $15 million lifetime cap. No cash tax is due unless the seller has already given away more than $15 million during their lifetime, in which case the gift tax rate reaches 40%.⁵

Splitting the Gift Between Spouses

Married sellers who both consent can split the gift, combining two annual exclusions for a $38,000 threshold per recipient. Splitting a $50,000 gift of equity leaves only $12,000 charged against lifetime exemption instead of $31,000. Both spouses have to file Form 709 for the year, even if only one owned the property.³

Filing Form 709

The seller reports the gift on IRS Form 709, 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 keeps a running tally against the lifetime exemption.³

Extending an income tax return automatically extends Form 709 by six months. If you are not extending your income tax return, Form 8892 gets you the same six-month extension for the gift tax return alone. Either way, the extension buys time to file, not time to pay.⁶

Capital Gains on the Sale Portion

Families often miss this piece. A below-market sale intended partly as a gift is what the IRS calls a bargain sale, and the sale portion is still a sale.⁷ If the price exceeds the seller’s adjusted basis, the difference is a taxable gain.

Take a parent who bought the home decades ago for $200,000 and sells it to a child for $350,000, with the property appraising at $400,000. The parent has a $150,000 capital gain on the sale, entirely separate from the $50,000 gift of equity.

For most families this produces no bill. If the property was the seller’s principal residence and they lived there at least two of the five years before selling, the Section 121 exclusion shelters up to $250,000 of gain for single filers and $500,000 for married couples filing jointly.⁸ That covers the seller’s gain in the vast majority of family gift-of-equity transactions.

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

The Buyer’s Cost Basis

The buyer pays no tax at closing, but the transaction fixes their cost basis, and that basis controls their tax bill when they eventually sell. Because the buyer pays something and receives part of the value as a gift, the IRS treats this as part-gift, part-sale. Under Treasury regulations, the buyer’s basis is the greater of two figures:⁹

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

In typical family sales the purchase price is the higher of the two, because the seller acquired the home years earlier at a lower price. When the seller bought recently or poured money into improvements, the seller’s basis can be the higher figure, and the buyer inherits that instead.

How the Lower Basis Plays Out Later

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

Section 121 can absorb much of this if the buyer uses the home as a principal residence for at least two of the five years before selling, shielding up to $250,000 of gain, or $500,000 for a married couple.⁸ For properties that appreciate sharply or get converted to a rental, the lower basis from the gift can produce a real tax bill down the road.

When Actual Gift Tax Is Paid

If the seller has already used up their $15 million lifetime exemption and actually pays gift tax, the buyer’s basis gets an upward adjustment proportional to the property’s net appreciation relative to the total gift.¹⁰ The adjustment cannot push basis above fair market value at the time of the gift.¹¹ Rare in practice, but worth flagging for very large estates.

Medicaid Look-Back Exposure

One tax-adjacent risk deserves attention because it can dwarf the tax numbers. If the seller may need Medicaid-funded nursing home care within five years, a gift of equity can create eligibility problems. Medicaid’s look-back covers asset transfers made during the 60 months before a long-term care application, and a below-market sale counts as an uncompensated transfer for the amount of the gift.¹²

The penalty is a period of ineligibility. States compute it by dividing the uncompensated amount by the average monthly cost of nursing home care. A $50,000 gift in a state where care averages $10,000 per month yields roughly five months without Medicaid coverage, and there is no cap for larger gifts. Certain transfers are exempt, including those to a spouse, a disabled child, or an adult child who lived in the home as a caregiver for at least two years before the seller entered a nursing facility. A straightforward sale to an adult child who was not a caregiver does not qualify. For sellers over 60 or in declining health, this is a conversation to have with an elder law attorney before closing.

Records to Keep

The buyer should hold the closing disclosure, the gift letter, and the appraisal for as long as they own the property and for at least three years after they sell. Those documents prove purchase price and establish basis; reconstructing basis years later without them tends to cost real money in overpaid tax.

The seller should keep the same closing documents along with the filed Form 709 and records of the original purchase price and any capital improvements. The seller’s adjusted basis matters for the buyer’s basis calculation, and the Form 709 filing history matters if the seller’s estate is later reviewed for estate tax.

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