Quitclaims are sometimes used to transfer property interests from one family member to another, or between divorcing spouses. Parents might wonder if they should use quitclaims to pass property to children to avoid the probate process. It’s easy enough to do. The homeowner signs the document with a notary, takes it to the county recorder of deeds, and has it recorded. Simple. No wonder adding someone to a deed or relinquishing rights through a quitclaim is often (mistakenly) called a “quick claim” deed. But what does the Internal Revenue Service think?
Quitclaims Are Taxable Events
One common myth about quitclaims is the notion that they transfer property tax-free. That’s not necessarily so. In fact:
- Unless the property goes to your spouse, quitclaiming is usually a taxable event and should be declared to the IRS using Form 709.
- Especially if you’re passing a whole or part home ownership interest along to your adult children, the Internal Revenue Service is interested.
- If no money is changing hands, then the conveyance is a gift. The federal gift tax provisions apply to the current fair market value of the transferred property.
Even if no taxes apply in a given situation, it’s best to know how tax policies and quitclaims interact. The IRS says more about gift tax considerations and exclusions here.
Pro tip: Take care to avoid inadvertently giving up a homestead exemption or property tax assessment cap. This can happen when the title changes hands, unless the recipient is a spouse or a living trust. State law may offer you property tax assessment advantages for a parent-to-child transfer. For example, California lets a parent transfer a primary residence to an adult child without a new tax assessment.
Quitclaims “Carry Over” the Giver’s Tax Basis
A recipient of a free, quitclaimed property who later sells the gift house must declare the price that was originally paid for the house as its tax basis. Here’s why many parents ultimately opt to leave a home to a child in a will or trust instead, rather than simply give it to the child:
- If you bequeath your home to an adult child through your last will, the inheritance will qualify the recipient to claim a stepped-up tax basis for the home. This can offset taxable capital gains considerably.
- A revocable trust, which bypasses probate, similarly helps your beneficiaries reduce their tax burdens. They will not have to pay tax on your gains in market value over the length of time you have owned the home.
In contrast, the capital gains you have earned over your years of housekeeping are carried over to the recipient through a quitclaim.
Say you’ve owned the home many years. Its market value is now $50,000 higher than it was when you acquired it. Quitclaim it to your children, and when they go to sell, they have a tax liability for that rise in value.
Note: Changes in administrations mean changes in tax policy and law. During or after 2021, the step up in tax basis for beneficiaries of wills and trusts could be eliminated. Deeds.com is watching and reporting on this issue. Bookmark our articles page to follow real estate trends and policy changes.
When Are Quitclaims Not Taxed?
Quitclaims are sometimes used to clarify ownership among heirs, to bring a new spouse onto a title or remove a divorcing spouse from a title, to make a charitable donation of property, or to move a home in or out of a revocable trust. Quitclaiming a property is not a taxable event if done for these reasons:
- To clear up a cloud on title. Sometimes people sign quitclaim deeds to officially remove their name from a chain of title. Using a quitclaim, someone with a possible claim to a property can clarify and affirm that they have no interest — thus removing ambiguities from the title. This is a clarification, rather than a gift.
- During divorce. A joint owner who leaves the whole interest in the home to a divorcing spouse can relinquish the property using a quitclaim without incurring tax.
- To donate the property to a tax-exempt charity.
If the giver keeps a “reversionary interest” in the home, like a life estate, gift taxes will not apply and that interest will remain part of the owner’s taxable estate.
There is also no tax when an owner quitclaims the property into an LLC or a living trust; but as other tax considerations apply, it’s important to consult with your tax expert or real estate attorney for guidance when making these decisions.
Pro tip: Wills and trusts are not the only alternative to quitclaims for passing property to heirs. For example, a transfer on death deed, if it’s an option for real estate in your state, may fit the bill.
What About Using a Quitclaim in a Sale?
Quitclaim deeds rarely appear in regular home sales, but there are instances in which money changes hands in a conveyance by quitclaim. In these cases, the IRS considers the transfer a taxable sale.
If the transferor of a quitclaim deed in a home sale lived in the home as a primary residence at least two years of the past five, capital gains of up to $250,000 ($500,000 if the quitclaim is conveyed by a couple filing jointly) are excludable from tax. The excluded amount is taken off the taxpayer’s total allowable lifetime exclusion.
When investor-owners convey their properties, they are taxed on their capital gains. Some investor-owners opt to convert rental property into a primary home long enough to benefit from the lighter tax burden. Some deferment strategies are available; a tax expert can go through the current benefits of these in case-specific situations.
And don’t forget to check for possible city and state transfer taxes if money has changed hands.
Avoid a Common Quitclaim Pitfall. Ask: Have Outstanding Property Taxes Been Paid?
Before transferring a title through a quitclaim, the owner must pay any outstanding property taxes on the house. Otherwise, clear title is not being transferred, and the taxing entity could claim the property.
As long as the state, city, or other tax jurisdiction has a legal claim to the property, the quitclaim deed can be held invalid. For similar reasons, the owner must resolve federal or state income tax liens on the property before transferring the title, to ensure a valid conveyance.
As we have regularly observed at Deeds.com, special care must be taken with quitclaims. A quitclaim is not a warranty deed. It doesn’t come with a title search. So, if you or your business will receive an interest in property through a quitclaim deed, you’ll need to figure out if there are any loans, liens, or taxes due on the home. You could, for example, later find out that the state had already repossessed the property on account of nonpayment of property taxes at some point before you received the deed. Because of possibilities like this, you need to be sure you are receiving an interest at all!
Pro tip: If you or your business is receiving a quitclaimed property interest, proactive self-defense makes sense. It’s a smart move to engage the services of a title insurer to run a title search before you accept the deed.
Convey With Care
This article is provided for general knowledge, and not meant for use as tax advice or legal guidance. Whether you are transferring, receiving, or challenging the quitclaim of a property interest, seek the advice of a real estate attorney in the area where the house is located.
Transferring property by quitclaim is simple to do. Yet it can lead to unintended consequences if certain aspects of the transfer go unnoticed or misunderstood. And those consequences are not so simple to undo.
The integrity of a chain of title matters, and every deed should be handled with care.
Photo credit: stevepb, via Pixabay.