Tax Consequences of Passing Your House to Your Children
by Eric Cohen • August 8, 2012 • Uncategorized • 0 Comments
If you want to give your home or vacation home to your children, there are four basic ways to do so. Each has advantages and disadvantages regarding their tax consequences:
Gift. You can gift the home to your children while you are alive, but gift taxes will have to be paid if the fair market value exceeds the unused portion of your lifetime gift tax exclusion of $5.12 million (in 2012, up from $5 million in 2011). Once you make the gift, you’ll either have to move or pay rent to your children. When your children sell the home, their taxable gain will be calculated based on your tax basis in the home plus any gift taxes paid.
- Sale. Another option is to sell the home to your children at fair market value and then give them a long-term mortgage at current mortgage rates. You are actually selling your home, so consider current tax laws before using this strategy. If the owner has lived in the home for at least two of the preceding five years before selling, single taxpayers can exclude $250,000 of gain from income, while married taxpayers filing jointly can exclude $500,000 of gain. Again, if you stay in the home, rent must be paid to your children. If the mortgage isn’t paid off when you die, the remaining equity in the house can be bequeathed to your children.
- Bequest. Under current law, if your children inherit the home after your death, their tax basis will be stepped up to fair market value on the date of your death. Any appreciation from the time you purchase the home until it is inherited will never be taxed as a capital gain. However, your home’s value will be included in your taxable estate and may be subject to estate taxes, depending on your taxable estate’s size.
- Trust. You can put your home into a qualified personal residence trust (QPRT), while retaining the right to live in the home for a specified number of years. You retain ownership and use the property during that time. At the end of the trust’s term, ownership passes to your beneficiaries. The gift taxes value of the transfer is determined at the trust’s inception based on the present value over the trust’s term. Lower values are assigned to the gift when interest rates are higher and the trust’s term is longer. Any future appreciation is removed from your estate and not added to the gift’s value. Depending on the gift’s value, you may have to pay gift taxes or use a portion of your lifetime gift tax exclusion. You must outlive the trust’s term or the home will be included in your taxable estate at its current fair market value. If you continue to live in the home after the trust terminates, a fair market value rent must be paid to your beneficiaries. Your heirs’ basis in the home remains the same as your basis plus any gift taxes paid.
About Eric Cohen
Eric Cohen, CPA is the President and Founder of E. Cohen and Company CPAs, a full-service CPA firm serving nonprofit organizations, government contractors, professional service companies and other industries with audit, tax and business advisory services for over 20 years. The firm was commended as a SmartCPA Reader's Choice by SmartCEO magazine and a Top 10 “Best Accounting Firm to Work For” by AccountingToday magazine. For more information, visit www.ecohencpas.com or call 301-917-6200.