Many people wonder if it is a good idea to give the family home to adult children during their lifetime. Others attempt to avoid probate by adding an adult child as a joint tenant on the property. While it is possible to do this, giving away all or a portion of the family home can have major tax consequences and may subject the property to your children’s creditors or a divorcing spouse.
Let’s start with the basic income tax considerations. Under current IRS rules, when you give anyone money or property valued at more than $15,000 in any one year, you have to file a gift tax return. However, this is only a reporting requirement, because you can now gift a total of $11.18 million over your lifetime without incurring a gift tax.
While your residence is most likely worth less than $11.18 million and you will not have to pay any gift taxes if you give it away, you will still have to file a gift tax form, (called a “Form 709″), attached to your income tax return. The Form 709 informs the IRS of the amount that will be deducted from the lifetime exemption from estate taxes. Upon your death, if the amount of all prior gifts and the net value of your estate exceed $11.18 million, your estate will pay estate taxes on the amount over $11.18 million. The estate tax rate is currently 40%.
The recipient of the gift does not have to file a gift tax return or pay taxes on the gift. However, upon receipt of the house, the children take over your “tax basis” in the property, which is generally the original cost plus capital improvements. If they later sell the house, they may be facing steep income taxes on the gain.
For example, suppose you bought the house years ago for $100,000 and did no improvements. If you give your house to your children during your lifetime, their tax basis will be $100,000. If the children sell the house after your death, they will have to pay income taxes on the difference between $100,000 and the net selling price. If they sold the house for $520,000 and realized a gain of $400,000 on the sale, that gain would be subject to income taxes. Assuming the sale qualified for capital gains tax treatment, the children would likely pay federal capital gains taxes of 15% and state income taxes of 9.3%, (both of which can be higher or lower depending on income), for a total of 24.3% in taxes on the gain. A gain of $400,000 could result in a tax bill of $97,200!
Inherited property does not face the same taxes as gifted property. If the children were to inherit the property following your death, the property’s tax basis would be “stepped up,” which means the starting point for measuring capital gains taxes would be the fair market value of the property as of your date of death. For example, if the children inherited property worth $500,000 after your death, that amount would be their starting point to measure any taxable gain. If they then sold it shortly after your death for roughly the same amount, there would be no income tax liability. Even if they waited a year or two before selling the property, the gain would be much less than if you had gifted the property during your lifetime.
Beyond the tax consequences, gifting property to children can affect your eligibility for VA benefits and Medi-Cal coverage for long-term care. It can also subject the property to your children’s creditors or their divorcing spouses, who may be able to force a sale of your home while you’re still living there.
Before giving the family home to your children, or putting a child on title as a joint tenant, consider a consultation with a qualified elder law attorney to discuss the alternatives. The primary solution (among other options) will be to place the property in a revocable trust. A revocable trust, also known as a “living trust,” will: 1) protect the property from your children’s creditors, 2) preserve the step-up in basis, 3) avoid probate, and 4) preserve eligibility for VA benefits and Medi-Cal for long-term care.