A question we get all the time from our clients is whether our clients should go ahead and give their personal residence to their children. While it initially may seem like a good idea, this article from NJ.com, “By Deed or by Will? How to Transfer your Home to you Children,” lists a number of traps you may run into if you decide to gift your residence to your children.
First, to the extent that the gift of your residence is worth more than $15,000 to each child, you must file a gift tax return on before April 15 of the year after the gift was made. While it is unlikely that any gift tax will be due as a result of the gift (unless the residence is worth more than $11 million), a gift tax return is still required.
Another tax consequence of gifting your residence during life is the likely existence of large, unrealized capital gain. If the residence was purchased many years ago, the residence has likely experienced an increase in fair market value, which means you have an unrealized capital gain in the home. By gifting the residence during life, your children will take a “carryover basis” in the property (i.e. the amount you paid for the house). After you pass away, and the children decide to sell the home, they will likely have a large capital gain that they must pay a 20% tax on. However, if you gift the house to your children through your will or trust after your death, the children will receive a “stepped-up basis” equal to the fair market value of the residence at your death.
For example, suppose you purchased your home for $40,000 in 1975 and the fair market value of your home is $400,000 today. You have an unrealized gain of $360,000. If you gift the property to your child during your life, and she sells the home after your death, she may owe a capital gain of $72,000 upon the sale of the residence. If, instead, you distribute the residence to your child at your death through your will, she will receive a stepped-up basis equal to the fair market value. When she sells the house for fair market value after your death, there will be no capital gain, and she will not owe any taxes on the sale of the residence.
Other traps that you may run into by transferring your residence during life include the loss of homestead exemption and other exemptions from real property taxes. In addition, transferring your residence may trigger Medicaid penalties if you apply for Medicaid benefits within five years of the transfer.
Also, while you may not anticipate problems in dealing with your child as the owner of your residence, we have seen many situations where problems over control do indeed arise. Also, we have cases where the child predeceases the parent, and the child’s heirs, consequently, become the new owner of the home! For these and other reasons, an outright transfer of your residence to your children may not be appropriate.
There may be other options available for your circumstances. You may transfer your personal residence to a management trust that may avoid subjecting your residence to probate. In addition, where tax planning is needed, the use of a Qualified Personal Residence Trust may help reduce your estate while reducing the amount of gift tax incurred when transferring your residence to your children.
If you have any questions regarding these issues, please call us at 205.536.8888 or contact us through our website at www.dfhlaw.com.
Vince Schilleci is a Shareholder at Dominick Feld Hyde and focuses on business planning, succession planning, real estate, taxation, estate planning, and probate administration.