‘The Big Move’ is a new MarketWatch column designed to answer questions about navigating the real estate world.
Do you have a question about buying or selling a home? Do you know where your next step should be? Email Jacob Passy at email@example.com.
My husband and I are considering a very great gift for our daughter and son-in-law, but I have concerns. We recently retired and bought beachfront property where we plan to spend most of our time.
Our daughter and son-in-law are early in their careers, but one day they want to have children. We all live in the same city, which is in an expensive part of the country. House prices are only rising where we live and we fear our daughter may not be able to save enough to buy her own house one day.
My husband mentioned that if our house is just empty most of the time, we might as well give it to our daughter as a gift now instead of her inheriting it later. I loved the idea and suggested that we give our daughter the opportunity for Christmas.
We are working on the various tax consequences and I am starting to worry that this could be a mistake. It will be some time before we take off our things and settle completely in our beach house anyway. So I wonder if there is a better way to ensure our daughter has an affordable home for years to come. What advice do you have
With best regards,
Santa has a brand new pad
How happy is your daughter to have such generous parents. You are not alone if you are concerned that your child can afford the housing costs. I have spoken to parents in a very similar situation over the past few years. In fact, as the cost of owning a home has increased, so has the number of parents helping their children in one way or another.
You are right to guess such a great gift. A number of tax considerations play a role here.
For starters, you need to consider how this works from a gift tax perspective. The Internal Revenue Service allows individuals to give up to $ 15,000 per year per person tax free. Of course, your home is worth more, but that doesn’t mean someone would pay tax on the gift itself – at least at the federal level. Each taxpayer currently has a lifetime gift tax exemption of $ 11.58 million.
“The irrevocable gift of the home can make up a large portion of the taxable estate,” said Ian Weinberg, financial planner and CEO of Family Wealth & Pension Management of Woodbury, NY. A very generous unified gift and estate tax credit is now available at new administration could decrease. “
Under President-elect Biden, tax legislation could become less generous for wealthier Americans, which could increase taxes under these rules.
Continue reading: This is how you give your adult child your home tax-free
The tax considerations do not end with the gift tax, however. There are capital gains taxes to consider too – and this is where a gift of this kind becomes difficult. If you donate the house to your daughter, she’ll be the one who pays capital gains taxes one day when she sells it.
“Assuming the home increased in value over time, parents would avoid paying capital gains taxes that they might pay if they sold the home by giving it away instead,” said Daniel Flanagan, partner at Canby Financial Advisors of Framingham, Mass. Capital gains taxes would ultimately still be paid by the daughter and son-in-law if they sold. “
This may be good business for you, but it could cost your daughter a lot. That’s because of how the cost base carries over. When calculating the capital gains made from selling a home, you take the selling price and subtract the price originally paid for the home (plus or minus the cost of improvements or depreciation).
If you donate a home to someone, the cost base remains the same as for the original owners. This is different from what happens when you inherit a house – inheriting a house increases the base. This means that instead of the original basis, the heir calculates all capital gains based on the market value of the home at the time of inheritance.
Let me illustrate this with a simple example. Let’s say you bought a home for $ 100,000 20 years ago that is now worth $ 600,000 and has spent around $ 50,000 on repairs since then. If you sold it today, the capital gain on the sale would be $ 450,000. At the federal level, you can exempt capital gains up to $ 500,000 from home sales, provided you meet certain requirements.
You need to know if the child would use the house as a residence or as a rental / investment property.
Now let’s see what happens to your daughter when she receives the house as a gift and later sells it. Because of how the base works, its $ 100,000 capital gain cost base would be the same as yours. But maybe the house will be worth more in about 10 years, pretend it’s $ 750,000. Assuming she made no further improvements to the home, her profit from sales would be $ 600,000. Because it’s over $ 500,000, she’d owe taxes on some of the sales.
This really just scratches the surface of the various tax considerations as these rules vary at state and local levels. “You need to know if the child would be using the house as a residence or as a rental / investment property,” said Brooke Salvini, a member of the American Institute of CPAs executive committee on personal financial planning. “This could have an impact on how best the property can be donated.” In California, Salvini said, a new law on the books that goes into effect in February will eliminate the ability to preserve property tax base when transferring real estate to a child who does not intend to use it as their primary residence.
There are ways to reduce the tax liability that the house represents, such as: For example, simply allowing your daughter to inherit it later or investing it in a trust. However, these options require careful planning and should be worked out with a financial professional.
There are other financial considerations beyond the tax implications of such a gift. Yes, your daughter and son-in-law would avoid the cost of building a down payment and a mortgage if you gave them the house – but can they afford the cost of property taxes, insurance, maintenance and utilities?
Some of the experts who gave me feedback on your situation argued that there is a financial lesson that could be lost if there was no mortgage repayment. “I prefer the recipient of the generosity of their parents to have some skin in it, as it allows them to better assess what they are getting, as they have to demonstrate some financial liabilities for the ‘investment’, be it for a home or an education “Said George Gagliare, a financial advisor at Coromandel Wealth Management in Lexington, Massachusetts.
With that in mind, I could suggest an alternative: stop the down payment or even help out with the monthly cost of the mortgage. If you decide to sell your old home now, the proceeds from the sale could go in that direction. This way, your daughter and son-in-law will have support but also avoid messy tax situations while you learn important financial lessons in the meantime.
Whatever you do, I encourage you to speak long – not just with your husband, but with your daughter as well. I am sure she will be very grateful for the generosity of your offer, even if she does not receive a keychain with a bow at the top under the Christmas tree this year. And with that, I wish you all a great vacation.