There is no gift tax unless you transfer your property while you’re alive. When you die, whether you pass the property to your children by the laws of intestacy, have a will and name them as beneficiaries, or put it in a trust, if the kids turn around and sell the property shortly after, there shouldn’t be any income tax issues. However, if the beneficiaries hold onto the property for a number of years and then sell, your beneficiaries must pay capital gains tax on whatever the sales price was, less the appraised value at the time of death. For most clients, we will advise to get an appraisal on the property because that establishes a cost-basis.
Under current law, each spouse can pass up to $11,000,000 to their children without triggering estate or gift tax. Inheriting a home is not a taxable event, as it relates to income or capital gains tax. Many times, clients contemplate transferring property to their children while they’re still alive. This is called an inter vivos gift and may trigger tax consequences. When you purchase a property, the purchase price is your basis, which is what we use to determine if there’s going to be any tax on the sale.
Under the IRS Code, if it’s a single person, there is a $250,000 exemption on appreciation. If you bought the house for $250,000, it went up to $500,000, and you sold it for $500,000, you’re not going to see any tax because of that $250,000 exemption. But for every dollar over that, you would pay capital gains tax. In order to qualify for the homeowner’s exemption, you have to be the owner and have been living in the house for two out of the most recent five years. The issue arises when it’s not your primary residence and you haven’t been living there those two out of the most recent five years. Parents need to consider that when they give the property to a child while they’re alive, they’re not only gifting the property, but they’re gifting their basis in the property. If I purchased a home for $100,000 and gifted it to my child, when that child sells that property, they’re going to have to calculate capital gains tax based on the sale price, minus that basis of $100,000. They’ll have to pay 15 -20 percent in capital gains tax, depending on that child’s marginal income rate for that year.
Once you give the property to the child, it is longer your property. If there’s income being generated from it, that income is now lost. If the child is in a higher tax bracket, and if it’s a rental property, the taxable income will be higher because it’s going to be based upon that marginal income tax rate. Additionally, your child could have creditors that you are unaware of. Sometimes, children are not fully transparent with their parent(s). If they are soon to be divorced or they owe back child support or alimony, have defaulted on student loans, or owe a tax debt, the property is subject to those various creditors of the child who now owns mom or dad’s home or rental property.
When you “just add the child’s name to the deed”, you’re essentially making them the 50 percent owner of the property. In the case of older parents who are looking at potential nursing home care and don’t have the ability to pay for that care, you may have to rely on the state’s Medicaid program. In those cases, after that parent passes away, Medicaid is going to attach to the house and expect to be repaid from whatever value is still in the parent’s name. If you’re trying to protect the house from a claim from Medicaid, the best thing to do is to put the house into a Medicaid Asset Protection Trust. We structure it in a way to retain all the tax benefits and to qualify for the homeowner exemption under the IRS rules. Because it was transferred to an irrevocable trust, there’s nothing left in the parent’s estate for Medicaid to come after, following their death.
Giving your home to a child through a life estate is not a bad idea in most cases, which is an irrevocable transfer to the child. If the parents change their mind later, they must obtain the child’s consent to unwind that transaction. If they wanted to sell it, the child would have to sign off on it because it would extinguish the child’s future right to own the home. If there’s a falling out between the parent and the child, it can complicate matters for the parents when they try to sell the house or later decide to put it into a trust or give it to a different child. They are unable to do those things without the consent of the child that they’ve put on the deed with the retained life estate.
Sometimes, people will try to get around these issues by selling their property to the kids at a bargain price. The IRS is going to look at the fair market value and then they’re going to look at the price for which you sold the property, and the difference will be treated as a gift. If the difference between the market value and the price for which you sold to your children is over $15,000, that triggers the requirement to file a gift tax return with the IRS. The failure to do so can result in a penalty of $25,000. If you’re going to do such a thing, you want to make sure to obtain tax advice from a competent professional, like a CPA or tax attorney.
Under any scenario where you are selling or gifting the property to the kids, it will no longer be your property. The children will have the ability to evict you from that property. Once you transfer title, you no longer have any control over that property. You’ve given it over to someone else to make the decision about whether you have the ability to live there. If you’re going to enter into one of these transactions, it is good to also do an occupancy agreement that gives you the right to live in the house for the rest of your life. You could also probably sell it to the kids and rent it back. However, if the kids buy the house at full price and you continue to live there and you don’t pay rent, that’s going to be treated as a gift each month, based on the fair market value rent. That would need to be reported as income to the parents or potentially trigger the requirement to file that gift tax return.
Many times, people with large estates are looking for a mechanism to reduce the value of the estate, which reduces the estate tax or gift tax that must be paid following their death. One option is a Qualified Personal Residence Trust (“QPRT”). With a QPRT, the parent is the grantor creating the trust and the kids are the trustees. Each year, a portion of the property is pushed outside of the parents’ estate, so that at the end of the term (8 or 10 years), the parents no longer own the property. In order to comply with the IRS code, once the term of years has run, the parents now must pay rent to the trust at fair market value. Otherwise, the IRS might claw back the transaction and conclude that the full value of the property is still part of the parent’s taxable estate.
If a minor child inherits property in Tennessee, outside of a trust, there needs to be a guardian of the estate named and appointed by the court to manage the property for the minor. The court will want to supervise the management of that property. They will require an accounting of any assets in the child’s name. You’d have to account for the assets on hand at the beginning of the accounting period, income received during the accounting period, and justify any disbursements that were made. The Court will want to know of any changes in form of assets, any outstanding liabilities and the value of assets on hand at the end of the accounting period.
If a surviving parent is appointed as Guardian of the Estate for the Minor, the parent must get authority from the court to use the property for the benefit of the child. The court is very diligent when there’s a surviving parent who’s acting as the guardian of the estate for their own child and is very strict on the use of those assets. There’s a presumption that the parent has the ability and the responsibility to provide for the needs for the child, so the court is very reluctant to allow a parent to withdraw money from that account and use it for the general welfare and comfort of the child. If they allow it, it will be for a limited purpose and for a limited period of time. The courts strongly feel that the parent has the obligation to pay for those expenses and that the money held in the guardianship account for the benefit of that minor should be there for that child when they reach the age of maturity.
For more information on Transferring Property To Your Children, an initial consultation is your next best step. Get the information and legal answers you are seeking by calling (615) 628-7775 today.