Gifting a home to children can be a more complicated estate transfer.
Houses are the most valuable assets for many people.
They can also be one of the more complicated assets to distribute to heirs.
Many aspects like taxes and how to divided the value of a home should be discussed and addressed in estate planning.
According to a recent Kiplinger article titled “2 Clever Ways to Gift Your Home to Your Kids,” each option has benefits and consequences to carefully consider.
Common ways of passing a home to children is through inheritance after you die, gifting the home while you are alive, and financing the child to purchase the home or sell it at a discount.
Although gifting and discounted sales can seem appealing at a time with high interest rates, you should fully review the numbers.
When selling your home at a discount, the IRS will consider the difference between the value and the purchase price to be a gift.
For example, a million dollar home sold to your child at $600,000 would trigger a $400,000 gift according to the IRS.
You must file a timely federal gift tax return Form 709.
This $400,000 will reduce your federal lifetime estate and gift tax exemption by this amount.
In 2022, the exemption amount is set at $12.06 million.
You will also need to consider the impact of federal income taxes if the home is sold.
Let us say you purchased the home decades ago and have a $200,000 tax basis in the property.
The tax basis will be split with the bargain purchase.
Forty percent of the amount will be allocated to the gift while 60 percent will be allocated to the sale.
The capital gain or loss will be calculated based on the sales proceeds.
Using the same numbers from the previous example, the parents would have made a $480,00 gain from the sale of the home.
This amount will not be taxable.
If an individual has lived in a home for two to five years prior to a sale, $250,000 of the gain can be excluded from income.
For couples, the number is double at $500,000.
The portion gifted to the child will not be taxed to the child.
Although this sounds good on the surface, the gifted amount will not received a step-up in tax basis.
There will be a lower tax basis, then for the home.
Another option is to provide a bargain sale and a loan to your child for the sale portion.
If your child cannot get a third party loan or if you simply would like provide a lower interest rate, you can also generate some monthly income for yourself.
The note must be written and signed by the child and the parents.
The note should also detail the dates and amounts of monthly payment.
You will also need the loan to have a maturity date and to charge an interest rate equal to or greater than the set IRS interest rate for the month the loan was made.
You should take all necessary legal steps for the home so your child can make deductions for the payments using the Schedule A of IRS Form 1040.
Although the interest you receive from the loan will provide income, you will need to pay income taxes on this amount.
You can also gift $16,000 to each child to account for the annual per-person limit.
By keeping within these limits, you may not be required to file a gift tax return for these transfers.
You should keep note payments from your children separate from the amount you gift to your children.
Although you have several options for transferring your home to your children, you should discuss your thoughts with an experienced estate planning attorney and your CPA to the best choice to satisfy your family, tax, and wealth transfer goals.
Reference: Kiplinger (Dec. 23, 2021) “2 Clever Ways to Gift Your Home to Your Kids”