Transferring Your Residence to Your Children

Four Pillars Law Firm works with the most knowledgeable professionals in our area to stay current on legislation, trends, and forecasts that affect elder law.  Occasionally, we interview professionals in tax law, accounting, financial services, healthcare and other fields, to get their “Four-Cast” on issues that affect estate planning and administration, asset protection, veterans benefits and elder law and LTC planning.  James A. Kelly, CPA, joined us for a discussion and brought forth the following points for consideration:

Four Pillars Law Firm: With the excessive cost of long-term care these days, we often hear stories of long-term healthcare costs wiping out people’s assets and life savings.  The fact that this problem faces families in all walks of life is exactly what compelled us to focus on Elder Law and Estate Planning.  Because the primary residence is usually the most valuable asset, many people wonder if it’s a good idea to transfer their home to their children during their lifetime.  James, our question is:

 Should you transfer your primary residence to your children during your lifetime?

James A. Kelly, CPA:  The answer depends on two components: 1) the way your home is valued by the IRS and whether a transfer now would subject your children to a larger tax bill, and 2) whether a transfer would disqualify you from receiving government assistance when you need it most.  Of course, you must also consider your own personal goals and comfort level when considering transferring such a valuable asset.

LEGAL LOSS OF CONTROL WITH DEED:  As an initial concern, it is important to consider the consequences of transferring ownership of your home.  The moment you sign the deed, you no longer own your home; your children now hold legal Title to your home. If you continue to live in your home, your children effectively are your landlord.  In the unfortunate event of a family dispute, your children could take legal action to have you removed from the property, and then sell it.  Even if you never encounter a family dispute, if any of your children experience financial or legal troubles (such as a divorce or car accident), your home becomes an asset that may be seized by creditors.  In that event, a forced sale would also leave you without a home and looking for a new place to live.

TAX BURDEN FOR TRANSFER NOW:  If you give your home to your children now, your children will be saddled with your “Tax Basis” in the property.  Tax Basis is the cost basis of your home, which the IRS calculates by adding the actual cost of any improvements (renovations) you’ve made to your original purchase price of your home.  Because real estate generally “appreciates,” or increases in value over time, the market value of your home is likely far higher than your Tax Basis.

If you give your home to your children now, your children keep your original, low Tax Basis.  If your children later sell your home, the IRS will charge Capital Gains Tax on any sales proceeds received above your original Tax Basis.

For example:  Bob originally bought his home for $100k in 1970.  Today, the home is valued at $250k.  Today, Bob gift deeds his home to his daughter, Sally, who keeps Bob’s Tax Basis of $100k.   Later, Sally sells the home for $255k.  The IRS imposes a Capital Gains Tax on all proceeds above the original Tax Basis (which is $100k).  Upon selling the house, Sally owes the IRS Capital Gains Tax on $155k of the proceeds. 

Note—there is an exception.  If your children own and live in the property for two full years before selling the house, it may be considered your children’s “primary residence.”  In that case, there may be no Capital Gains Tax owed unless the house sells for more than $250,000.00 over your original Tax Basis in the home. This amount increases to $500,000.00 if your children are married and file jointly with a spouse.

TAX BENEFIT FOR WAITING:  If you do not transfer your home to your children during your lifetime, but instead, your children inherit your home when you pass away, your children will enjoy a potentially huge tax benefit.  As heirs, your children will receive a “Step-Up in Tax Basis”.  This “Step-Up” discards your old Tax Basis and resets the Tax Basis for your heirs—your heirs are given a new Tax Basis based on the home’s current Fair Market Value on the date of your death.  This way, if your heirs then sell the home at the current Fair Market Value, there will be little to no proceeds received above the new Tax Basis, and therefore, little to no Capital Gains Tax due upon sale.

For Example: [Based upon Example above] If the home is inherited, Sally receives the home upon Bob’s passing.  As an heir, she is given a new Tax Basis of $250k.  If Sally sells the home for $255k, the IRS will only recover Capital Gains Tax on $5k of the proceeds.

 OTHER POINTS TO CONSIDER:  Of course, there are numerous other considerations that should be made before making such an important decision.  An experienced Elder Law Attorney is familiar with strategies that maximize the benefits of owning your home, while also protecting against the risk of loss of your home due to skyrocketing long-term care expenses. By discussing your own situation with your elder law attorney, as well as other trusted financial and accounting advisors, your particular goals can be achieved now, during life, while securing peace of mind that your home and your children’s financial future are protected.  Although it is not possible to cover our entire conversation in this newsletter, stay tuned to the Four Pillars Law Firm blog for additional discussion on this topic (e.g. when and how to properly transfer your home and other valuable assets) as well as other tax topics discussed. 

James Kelly is the founder and principal of James A. Kelly, CPA in Wilmington, NC, a public accounting firm specializing in tax and financial services for small and medium-sized companies.  Prior to starting his firm, Kelly served with the U.S. Army’s 25th Division at Schofield Barracks, HI and holds airborne, and expert infantry qualifications.  After his military service, Mr. Kelly served with the United States Peace Corps in the Retaluleu province of Guatemala.  During his tour he assisted in a wide variety of business, community development and health projects throughout the country.

James holds a Bachelor of Science in Business Management from Appalachian State University and a Bachelor of Science in Accounting from The University of North Carolina at Wilmington. He has been in public accounting since 1997 and is involved with several local charitable organizations.  James and his wife Amy have a nine year old daughter Lauren.

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