How to Pass Your Home to Your Children Tax Free:
For many of us, our home is the most valuable asset we will own during our lifetime and most of us would like to leave it to our children. Giving your house to your children can have tax consequences but almost all of us can accomplish this tax free. The best method to use will depend on your individual circumstances and needs.
Leave the house in your will
One simple way to give your house to your children is to leave it to them in your will. As long as your total estate is valued at less than $5.45 million (in 2016), your estate will not pay taxes. Additionally, when your children inherit the property, it reduces the capital gains taxes they will pay if they sell the property. Capital gains taxes are taxes paid on the difference between the basis in property and the selling price. If your children inherit property from you, the property’s tax basis is stepped up, which means the basis would be the value of the property at the time of your death, not the original cost of the property.
One big downside to this plan is that if you ever need Medicaid during your lifetime for long-term care, such as a nursing home, Medicaid is likely to put a lien on the property and it will have to be sold to pay back Medicare after your death.
Gift the house
There are almost always better options than outright gifting your house to your children and I almost never recommend it. That being said, most of us will not have any gift tax consequences if we give our home to our children during our lifetime. If you gift property worth more than $14,000 per year ($28,000 per couple) in any one year, you will have to fill out a gift tax return. However, if your residence combined with other gifts of assets to your children total less than $5.4 million, you won’t have to pay gift taxes but will still have to file a gift tax return.
A major downside of gifting the property is that there can be considerable capital gains tax consequences. If you gift property to your children during your lifetime, it does not receive a step up in basis as it would if it were inherited. If you give the property away, the tax basis (the original cost) of the property becomes the tax basis for the recipient, resulting in potentially much larger capital gains tax for your children if they later sell the house.
For example, let’s say you bought your home for $50,000 thirty years ago, it has grown in value to $100,000 and you gift it to your child or children. The children later sell it for $110,000. Their tax basis would be $50,000 and the children would pay capital gains on $60,000. If you chose to leave your house to your children in your will and it is worth $100,000 when you pass and they later sell it for $110,000, the tax basis for your children will be $100,000. Then, they only have a $10,000 capital gain.
Another potentially serious downside is that if you ever need to apply for Medicaid for nursing home care and you gave away your house less than five years prior to applying for Medicaid, you will be ineligible for Medicaid for a period of time called a transfer penalty. The length of the penalty depends on how much the assets you gave away were worth.
One of the biggest reasons not to give away your house is that if you do, it’s no longer your house. Your child or children may have every intention and desire for you to remain in the house you give them for as long as you are able or want to. But, what happens if something happens to your child?
The house now belongs to someone else and is affected by their divorce, creditors or lawsuits including accidents they might be in, or heaven forbid your child should pass away before you do and the house becomes part of their estate. There are almost always much better ways to get your house out of your name than giving it away outright to your children.
Put the house in a trust.
This is the method that I most often recommend to clients who are still relatively healthy and do not expect to have to apply for Medicaid for at least 60 months. If you transfer the house to an Irrevocable Trust and name your children as beneficiaries, it will no longer be part of your estate when you pass and there will be no estate taxes. If you have to have Medicaid to pay for a nursing home, the house will also not be subject to estate recovery. Your children, as beneficiaries of the trust, will get a stepped up basis as well. The trust can be written so that you have the exclusive right to live in the house as long as you are able to.
A potential downside is that because the trust is irrevocable, the home cannot be taken out of trust by you but it can be sold by your trustee (but not against your wishes if you still want to live there) and the proceeds remain in trust. The trust, through your trustee, could then even purchase another home for you to live in. This would be helpful if there was a need to downsize or move closer to family. Because the house is in trust, it is also protected from your beneficiaries (i.e. children’s) creditors, predators, death, illness and divorce, among other things.
Another downside is that just like giving the house away outright, transferring the property to a trust may subject you to a Medicaid penalty period if you need to apply for Medicaid within 60 months of transferring the property.
Figuring out the best way to pass property to your children will always depend on your individual and family circumstances. Always seek the advice of an authorized estate planning and elder law attorney to help you decide what method is best for you.
Contact Lee Treadaway by calling 706-291-0040 or visit his office at 901 North Broad Street Suite 350, Rome for a consultation. Also find him on Facebook at “Law Office of H. Lee Treadaway”