There are a lot of reasons why you might want to give your home to your adult kids during your lifetime. It can help your estate avoid probate later if it’s your primary asset and you don’t have much else of significant value. Or maybe you just don’t want to live there anymore, but you want to keep the house in the family. Transferring ownership to your children is an easy process. It could have tax consequences if you’re wealthy, but most people won’t have to worry about writing a check to the IRS.
What Taxes Might Come Due?
Only two taxes can come into play at the federal level for the donor of a property: the gift tax and the estate tax. The gift tax is a hefty 40 percent as of 2017. An estate tax might still come due after your death even though you’re giving the gift of your home during your lifetime. The transfer won’t incur income tax, although you can’t claim a tax deduction for the value of the gift, either.
The Gift Tax
The gift tax is payable by the donor of property, which is you if you’re the one giving the house away. The home is considered a gift for tax purposes if your children don’t pay you fair market value for the property or give you other assets equal to the home’s value. For tax purposes, the IRS effectively defines fair market value as what the property would likely sell for in a typical sale between parties who were under no type of duress to complete it.
The Annual Gift Tax Exclusion
The Internal Revenue Code does provide for “exclusions” from the gift tax, however – property you can give away without incurring a tax. Unfortunately, your home most likely won’t qualify for any of them. You can pay someone’s medical or educational expenses for them tax-free, and you can give your spouse unlimited gifts without paying tax if she’s a U.S. citizen. But the only break that gifts to your children might qualify for is the annual gift tax exclusion: $14,000 as of 2017, although it’s set to increase to $15,000 in 2018.
The annual exclusion is per person per year, so the fair market value of your home would have to be $14,000 or less to qualify if you give it to one child, or $28,000 if you give it to two children. Calculate $14,000 times the number of children who’ll receive the home to determine the amount of the exclusion. If you’re married, the IRS allows you to “split” the gift so you can double the amount of value given to each person.
If the value of your home exceeds the exemption amount, you must file IRS Form 709, the gift tax return. But here’s a bit of good news: This doesn’t necessarily mean you’ll have to pay a gift tax.
The “Unified” Lifetime Exclusion
There’s one more exclusion that can potentially spare you from paying a gift tax if you elect to use it, and this one is valued at $5.49 million as of 2017. Unless you’re very wealthy, it’s probably more than enough to cover the fair market value of your home if you want to give the property to your children.
This exclusion is called the lifetime exemption, or sometimes the unified tax credit. It covers all the gifts you give during your lifetime that don’t qualify for other exclusions. If you give someone $16,000 in 2017, $14,000 of that would be covered by the annual exclusion, and you can allocate the remaining $2,000 balance up to your $5.49 million lifetime exemption. No gift tax would be due. All you have to do is indicate that this is your choice when you File IRS Form 709.
The Effect on Estate Tax
There’s just one catch. This exemption is “unified” because it also covers your estate when you die. Every time you use it to avoid paying tax on a gift during your lifetime, that $5.49 million decreases by the taxable amount of your gift. Less will be available to shield your estate from estate taxes when you die.
Of course, if you don’t expect that your estate will be in the $5 million-plus range when you die, you have nothing to worry about. The unified credit should be adequate to cover all your lifetime taxable gifts as well as your estate. And it’s indexed for inflation, which means that you can expect it to increase each year to keep up with the economy.
And remember, each and every gift you give during your lifetime that exceeds the annual exclusion counts against the unified credit. It’s cumulative. So if you gave a $300,000 house to your kids five years ago and now you’re giving a $400,000 house, your $5.49 million unified credit is whittled down by $700,000 plus any other gifts that you’ve made. It ramps up to $5.6 million in 2018, and it doubles for married couples.
Capital Gains Tax
Your children don’t have to pay income tax on the value of the house because it’s a gift, not earnings. But if they turn around and sell it, they would probably be liable for paying capital gains tax on any profit they realize. For purposes of a gift, capital gains tax is due on the difference between what you paid for the property at the time you purchased it and what it ultimately sells for.
If you paid $100,000 for the house and your children sell it for $400,000, capital gains tax would come due – to them, not you – on $300,000 of profit. Contrast this to the “step up” in basis your kids would receive if you were to bequeath the property to them as part of your estate. In this case, their basis in the property would be its value as of the date of your death. If it’s worth $400,000 at that time and they sell the property for $400,000, no capital gains tax would be due.
Generosity doesn’t have to be taxing if everyone involved pays attention to the rules.
- IRS: Frequently Asked Questions on Gift Taxes
- USA Today: Gift Tax – 6 Ways to Avoid Paying the IRS
- Charles Schwab: The Estate Tax and Lifetime Gifting
- Elder Law Answers: How to Pass Your Home to Your Children Tax-Free
- MarketWatch: How to Give Your Home to Your Children Tax-Free
- Forbes: IRS Announces 2018 Estate and Gift Tax Limits – $11.2 Million per Couple
- You may give away more than $13,000 of tax free income each year provided that your gifts are not made to the same person in the same year.
- Check with a tax attorney to ensure that you are aware of the most current laws regarding gift and inheritance tax.
- You can gift your home to your children without placing it into a GRIT, but this could result in your children paying capital gains tax on the property if it has increased in value since you initially purchased it.
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