Honey, Should we give the kids the house?

Ronald Bush

50plus Magazine

 

 

The Situation

As they age, many parents (we’ll call them “Mom and Dad”) consider transferring the family home, their largest single asset, to their children.

 

Reasons to do this may include: avoiding probate and/or legal fees, saving time, helping the kids, simplifying, ensuring lifelong housing, rewarding the kids for caring for them, etc.  All are worthy reasons to give adult children the house. If done correctly, it can be a real blessing to everyone. But proceed with caution: without proper planning, it can become a nightmare.

 

Deeding the property seems easy enough, so why hire professional help — a lawyer, a CPA, financial advisor? They cost money, and how hard can it be to fill out a deed?

 

So, Mom and Dad get a blank deed, enter their children’s names and marital status, allocate 99% ownership to the kids and 1% to their grandbaby and record the deed with the county.

 

Mom and Dad think everything is fine, but after title is transferred, “surprises” may occur that they can’t fix. For starters:

 

Income Tax Surprise

 

The two most important tax benefits of home ownership include the tax exemption of $250,000/$500,000 and the “step-up in basis” when someone inherits property. What happens to these when property is gifted?

 

A donee of property takes title with the same tax basis as the donors. For example, suppose Mom and Dad bought their home for $50,000 in 1972 at a $50,000 tax “basis.” Now, today’s “Fair Market Value” of the same home is $600,000. The $550,000 difference between tax basis and the “adjusted sales price” is “gain,” ie, a longterm capital gain taxable by the federal and state governments.

 

After Mom and Dad pass away, the kids sell the home. The gain is taxable and added to any other taxable income they may have. This tax bill could have been avoided if Mom and Dad had planned it correctly.

 

Mom and Dad’s $250,000/$500,000 income tax exemption on the sale of a personal residence was eliminated when they gifted their home to the kids. Unless the kids also meet the requirements of living in it for “two out of the past five years,” they cannot take advantage of this exemption.

 

What about the “step-up in basis” for heirs to $600,000 when Mom and Dad died? The kids did not inherit the home, they were gifted it. This gift also eliminated the step-up in basis.

 

NOTE: If Mom and Dad own investment real property (not their primary residence) the step-up in basis also applies — only if the property is inherited. If gifted, the step-up in basis is lost.

 

Property held for investment or income has an added wrinkle called “depreciation recapture.” This is a tax levied on the amount of depreciation claimed during the period of ownership. The current rate of federal taxation is 25%, plus Oregon taxes of up to 9%.

 

If this property is inherited, the step-up in basis applies and the depreciation recapture tax, as well as longterm capital gains taxes, are NOT payable. But, if gifted, the donees also receive the depreciation recapture tax.

 

Proper planning can avoid these tax problems.

 

Ronald Bush is a Licensed Real Estate Broker with Equinox Real Estate. Reach him at 541-514-1141.