Giving away your home to your children before you pass away can have major tax consequences and prevent legacy planning opportunities. In spite of this, many people follow outdated advice of giving away property before they pass away.
Historically, estate and death taxes were applicable to most of the population. Today however, the Federal estate and gift tax exemption sits at $5.34 million per person. Many states have no estate and gift tax and those that do also have exemptions ranging from low to high. It is estimated that 99.7% of the population will not be subject to estate taxes. Thus, planning for the distribution of your assets to your family has changed.
A family home (especially when held for many years) is often a family’s most highly appreciated asset. When an appreciated asset is sold, the owner must pay capital gains taxes on the profit (there are some exemptions). The original cost of the property is referred to as the tax basis. When property is given away prior to death, the person receiving the gift also receives the giver’s tax basis. For example, suppose you or your parents bought a house years ago for $150,000 and it is now worth $350,000. If you give the house to your children (or your parents to you), the tax basis will be $150,000. If your children sell the house, they will have to pay capital gains taxes on $200,000 — the difference between $150,000 and the selling price. Recent changes to capital gains and income tax laws put the highest long term capital gains tax rate at 23.8%
On the contrary, if a home (or most other property) is inherited after the owner passes away, the person inheriting the property gets a “step up” in the tax basis. This means the basis would be the current value of the property. Thus, if you or your parents are not likely to be subject to estate taxes, inheriting the property through their estate can have significant capital gains tax savings.
Beyond the tax consequences, gifting a house to you can affect your parents’ eligibility for Medicaid coverage or long-term care. There are other options for giving a house to children, including putting it in a trust or selling it to them. Trust planning also allows parents to provide asset and wealth protection to their children. Before you or your parents give away a home, you should consult with one of our attorneys, who can advise you on the best method for passing on their home.