Many parents consider and assume that one of their children will succeed them in living in the family residence. Of course, this place may be the house in which the child grew up and spent a considerable amount of time. To return to such a place can be very special. But what in fact are the tax consequences of such an event? What happens if the parents wait until death? What if they want to make an outright gift of the property? Perhaps they wish to make a sale at a bargain price? What if they make a more traditional sale that involves financing?
*Outright Gift
In this situation the unified federal gift and estate tax exemption, which is $5.45 million for 2016, applies to the gift. Unless the home or taxpayer’s estate is worth millions, or such gift was preceded by other gifts of significant value, the homeowner should not be liable for any amount of gift or estate tax. In this situation the child’s tax basis on the home will be what the parent presumably paid for the property, which increases the likelihood of incurring capital gains tax on a later sale.
*Wait Until Death
Taxpayers planning on living in the family home until death may be observing the best course of action to save taxes, especially if the taxpayer’s estate is below the unified federal estate gift and estate tax exemption amount. A taxpayer’s home’s tax basis will be stepped up to fair market value as of the date of death. Thus, at this time, all involved family members will avoid capital gains tax on all of the property’s appreciation. And, because the value of the estate is below the estate tax exemption, the heirs will owe no federal estate tax.
*Bargain Sale
If a home is sold to an unknown party or stranger for less than fair market value (FMV), it’s simply deemed a bad deal and the IRS doesn’t really care or take notice. However, when a home is sold to a relative, it will be treated as a gift equal to the difference between FMV and the sale price. So if a house worth $500,000 and sold to a taxpayer’s child for $300,000, the taxpayer has made a gift in the amount of $200,000.
Remember that the $14,000 annual gift exclusion may be used to reduce this amount. The unified federal gift and estate tax exemption is then applied to the net amount of the gift. A positive aspect is that the bargain sale successfully removes all future appreciation from the parent’s taxable estate.
*Sale Financed by Mom and Pop
Instead of a bargain sale, taxpayers should consider making an installment sale for full market value. This may effectuate a parent’s ultimate purpose of affordably transferring the home to a child, with better tax consequences.
Parents can sell the property for a small down payment and carry the note, which should be always in writing. The loan should carry the applicable federal rate for interest on the loan as well. Also, the note should be secured by the house with a mortgage or deed of trust, which will enable a child to take a deduction for qualified mortgage interest. To ease the child’s financial obligation, parents can utilize the $14,000 per year gift-tax exclusion to donate as much as $56,000 per year back to a child and his or her spouse.
Another advantage is that the child’s tax basis on the property is now the purchase price, which reduces the chance he or she will owe any capital gains tax when the home is eventually sold again. And the parent taxpayer is still clear of paying any gift tax while the sale removes from the parent’s taxable estate any future appreciation in the value of the home. A few years after the sale, your child may be able to refinance and pay off the note, which has no further tax implications for the child or the deceased.
If you are a parent interested in selling or gifting your home to one of your children and have questions about the tax implications and consequences of both actions, call THE TAX EXPERTS at the Thorgood Law Firm www.thorgoodlaw.com. For a FREE consultation call 212-490-0704.
