It’s not unusual for a senior to consider gifting their home to a married child or to a grandchild. However, there are tax consequences to consider before you do this.
nj.com’s recent article on this subject asks “What should I know about taxes before I gift my home?” The article explains that you can gift your home or any other asset to anyone, provided that person is capable of receiving the gift and takes delivery or ownership of it. However, if the grandchild is a minor, the gift would have to be made either in trust with a trustee or through a Uniform Transfers to Minors Act (UTMA) account that has a custodian, until they attain the age of majority.
The federal government has a gift tax, but not everyone will be subject to the tax. That’s because each year, you can give anyone up to a $15,000 gift tax-free. If you’re married, you and your spouse could each make those gifts, totaling $30,000 per year, per recipient without any gift tax.
Gifts to an individual more than $15,000 per year that aren’t under an exclusion or exemption are subject to federal gift tax. As a result, you must file a federal gift tax return on IRS Form 709. However, it’s not likely that you’ll actually have to pay any gift tax, even though you have to file a return. The reason is that under the federal unified estate and gift tax system, each person has a lifetime exclusion from gift and estate taxes of $11.4 million, over and above the annual $15,000 per person gift tax exclusion. That number is doubled for married couples ($22.8 million). So, you can transfer up to $11.4 million, whether as a gift during your lifetime or as a bequest after your death, before any gift or estate taxes are actually due. Keep in mind, though, that if you make gifts that use up your $11.4 million exemption, that your exemption is reduced by that amount when your estate tax is calculated on your death.
In addition, you can make unlimited gifts to qualified charities without any gift tax consequences. The same is true for gifts to spouses, as long as both spouses are U.S. citizens. Payments of tuition or medical expenses for someone else are also gift tax-free if they’re made directly to the school or the medical care provider.
As far as whether and how to gift your home, there are income tax considerations to consider. If you sell your home and have a capital gain, you may qualify to exclude up to $250,000 of that gain from your income. The exclusion is up to $500,000 if you’re married and file a joint return with your spouse. To qualify for the capital gains exclusion on the sale of your home, you are required to have owned the home and also used it as your principal residence for at least two of the previous five years.
For example, say that you purchased a home for $200,000 and made capital improvements in the amount of $50,000. Your basis in the home is now $250,000. If you sell that home for $500,000, then you will have a capital gain of $250,000 ($500,000 sale price minus $250,000 basis). However, as long as you qualify under IRS principal residence rules, you could exclude the entire $250,000 gain when you sell the residence and therefore have no tax bill to pay.
If you gift the house to a child or anyone else, in most instances, your $250,000 basis would carry over to the recipient. Your child and their spouse would then have a $250,000 basis in the house. If they live in it for two years, then they could have a capital gains exclusion of up to $500,000, as long as they file a joint return, if they then sell it.
If you want to stay in your home, one option is to leave it to your child or grandchild in your will, rather than gifting it now. If your child inherits the house, then their basis in the inherited house would then be its fair market value on the date of your death instead of your original $250,000. This increased basis in the home would decrease the amount of any future capital gains if the daughter subsequently sold the home.
Another option would be to sell the house now to a third party, leverage the capital gains tax exclusion and then gift the money, instead of the home itself, to your child.
The best financial outcome would depend on the individual financial circumstances, future plans, and income tax brackets of the parent and child. There are additional factors to consider, such as the age of the house, its location and condition, whether your child would use it as their primary residence or as a rental and whether you anticipate that the house will increase in value over time.
One final note: if you gift the house to a grandchild, the generation-skipping transfer tax (GSTT) would apply in addition to the gift tax. This is a separate tax system that applies when gifts or bequests are made to a person who is two or more generations below the person making the gift or bequest, like a grandchild or great-grandchild. However, many of the same exclusions that apply for gift tax purposes, also apply for GSTT purposes. So, the odds are you won’t have to pay any GSTT for this specific transfer.
Talk to an experienced estate planning attorney to help you find the best strategy for you and your family.
Reference: nj.com (October 28, 2019) “What should I know about taxes before I gift my home?”