The Death Tax Series (Part 3 of 3)
We all worry about income tax, but there are other taxes that you need to consider when you’re dealing with an estate or a property that is switching hands either at death or during life. In the final part of our 3 part series, we will discuss the remaining information you need to know.
Part 3: Putting it all together: Should I put my children on the deed to my house?
Many parents want to ensure that their children inherit their house. Most people believe the easiest way to do this is to gift the house to their children while they are alive. The parents plan to live in the home until they pass away, but not own it. While this may seem easy, there are a lot of serious tax and liability consequences when you put your kids on the deed to your house.
First, your house becomes subject to your children’s lives. Specifically, if your kids have creditors, they can come after the house for the children’s debts. If your children are sued, the house you are living in is now involved in their lawsuits. Even worse, your child gets divorced, and now the house you gave to your son is involved in his divorce settlement.
When on government benefits, such as Medi-Cal, people believe giving away their house is the only way to prevent a Medi-Cal recovery claim. This is not true – although you are allowed to transfer your home under Medi-Cal rules, doing so could cause serious tax implications if not done properly.
For tax purposes, as we discussed in Part 1 of this series, if you gift away more than $14,000.00 in 2017 to an individual, you must file a gift tax return to the IRS. Under current law, you can give away $5,490,000 without having to pay additional taxes; however, even if your house is worth far less, you must still account to the IRS.
While you may not have to pay gift tax, if your children decide to sell the home at a later date they could realize significant income tax consequences. When you gift property away, the tax basis (what you originally paid for your house) is transferred to your children. For example, if you paid $60,000.00 when you purchased your home and you gifted your home to your children, when your children sell your home any gain or loss will be determined based on the original $60,000.00. So in 2017, now your home is worth $900,000; but, if you gift your home to your children and they decided to sell the house, they would realize a taxable gain of $840,000.00 (the fair market value minus the tax basis).
When your children inherit property from you, the result in the above scenario is much different because they receive a ‘step up in basis’ at the time of your death. This means that the tax basis for your house “steps up” to the current fair market value of the property, instead of remaining at the original purchase price. So, in the above example the gain or loss when your children go to sell the property is now based off of $900,000.00 (the fair market value). As a result, they do not recognize any taxable gain on the property.
Typically, the best estate planning technique that will allow your children to inherit real property from you is a living trust. In California, you need to transfer your property to your children through a living trust in order to avoid probate if your real property is valued $50,000.00 or more. If you do use Medi-Cal, a living trust also prevents Medi-Cal recovery when you pass away.
Before you decide to gift your house to your children, please call our office at (408) 402-4064 to schedule a no-cost consultation to discuss your options and ensure that you are able to provide for your children in the best possible way that will not result in unintended consequences.
Check out the rest of our three part series. In part 1, we will discuss the gift tax. in part 2, we will discuss the federal estate tax. In part 3, we will put it all together and conclude.