Consider Giving Your Home to Your Adult Children.
A Good Tax Accountant Can Make Gifting Your Home to Your Adult Children a wise tax move – here’s how…
Brown CPA Group, Ltd., – Tax Tip Tuesdays
by Ken Smith
Tax Tip Tuesdays Strategy No. 6: Gifting your home to your adult children.
It may be wise for many to consider transferring ownership of the home to an adult child. In many ways, the timing of this tax move could not be better because interest rates are still very low by historical standards and the federal estate and gift tax rules are probably as good as they are ever going to get.
However, before taking this potentially favorable tax move, let’s consider some of the major tax ramifications, as well as how it may impact the parent’s gift and estate tax situation and also how it may impact the child’s income tax situation.
The parent can make an outright gift of the home. If a parent simply gives the home to an adult child, the client’s $5.43 million unified federal gift and estate tax exemption is reduced dollar for dollar by the value of the gift. The taxable amount of the gift is reduced by the client’s $14,000 annual gift tax exclusion for one spouse, or $28,000 if the gift is made jointly by two spouses. [See IRC Sec. 2503(b).] If the child is married, the parents can make a joint gift of the home to both the child and his spouse. In this case, the gift tax exclusion would be 14,000 X 4 = $56,000 for four annual gift tax exclusions.
Unless the parents have already used up most of their $5.43 million lifetime federal gift tax exemptions by making earlier gifts, neither parent will owe current federal gift tax.
If the home is expected to appreciate, getting the home out of the parents’ estate is a good estate-tax-avoidance strategy. The only federal income tax impact on the parent’s tax situation will be loss of the qualified residence interest and property tax deductions.
The child in this tax scenario benefits from assuming his parents’ presumably low tax basis in the property. This means higher taxes down the road when the home is eventually sold [IRC Sec. 1015] However, a special rule under IRC Sec. 1015(a) says if the home’s value at the time of the gift is less than the parent’s basis, and the child and his spouse live in the home for at least two years, they will qualify for the $500,000 principal residence gain exclusion (IRC Sec. 121).
A parent should not make an outright gift of the home if she intends to continue living there. The IRS generally rules that the home’s full date-of-death value must be included in the parent’s estate for federal estate tax purposes, even if the parent was paying fair market rent to the child. (IRC Sec. 2036; Rev. Ruls. 70-155 and 78-409)
The best tax consequences for both parents and children is – a Full-Price Sale with Parental Financing.
If the parent sells the home to her child for full current fair market value, then takes back a note for most of the purchase price. This seller-financed deal will deliver the best tax results for both parent and child, especially when interest rates are low.
The parent can charge the lowest interest rate the IRS allows. This is the applicable federal rate or AFR. The parent must charge at least the AFR, or be subject to the dreaded below-market loan rules of IRC Sec. 7872. These rules should be avoided when possible.
Tax-wise, the parent simply sold the home for the fair market value. If the parents qualify for the $500,000 principal residence gain exclusion break, the parents will owe no federal income tax on the sale. There is no gift-tax issue because there is no gift, since the home was sold FMV. Estate tax-wise, the sale makes any future appreciation in the value of the home outside of the parent’s taxable estate.
On the child side of the sale, the child’s tax basis in the home is the amount of the sale. If he lives there at least two years, he will qualify for the 250,000 or 500,000 married filing joint principal residence gain exclusion. Alternatively, the parents can remain in the home without any issue because the house was sold at full market value.
Post-Mortem Transfer Could Be Best Deal of All – from the child’s tax perspective, the parent continues to own the property until death. The child can receive the home by bequest, which means the property’s tax basis will be stepped up to FMV as of the date of the parent’s death [IRC Sec. 1014(a)(1)]. Of course, this presumes it is not critical to get the home value out of the parent’s estate for estate-tax-avoidance reasons.
In summary, we discussed three different scenarios of a parent gifting a home to a child: outright gift, full market sale, and post mortem bequest. Each scenario has its own set of benefits and drawbacks depending on the tax objectives to be achieved.
To schedule an appointment to implement this strategy and others within the context of your unique tax situation, Contact Brown CPA Group, Ltd., at (847) 509-4100.
About the author: Ken Smith is an Enrolled Agent and Senior Staff Accountant with Brown CPA Group, Ltd. We know that success means different things to different people. While a business owner strives to maximize profits, increase efficiency and plan for succession; an individual client is more concerned with tax planning, wealth management, retirement and estate planning. At Brown CPA, we work with you on the total picture. Together, we succeed.
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