How To Pass Your Home To Your Children Tax-Free
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According to the National Association of Realtors, millennials make up the greatest population of homebuyers in America. However, a realtor.com study is finding that they are also having the hardest time finding a property within their budget.
In the Detroit housing market, median listing prices increased by more than 19% in March 2021, when compared to the year before, while average homes in the Grand Rapids area skyrocketed from $140,783 to a little over $230,000. The market may be expected to stabilize in the not too distant future as life begins to return to some level of normalcy, but our younger generation still needs all the help they can get to become homeowners.
You may be wondering how you can support your children in becoming homeowners, especially during such an uncertain economical time in our history. Whether you are considering gifting them a property now or eventually passing your home onto them, there are some things to consider to minimize any tax-related consequences. Here are some options to consider.
Leave the house to them in your will
The simplest way to pass your house onto your children is to include it in your will and leave it to them. So long as your total estate amounts to under $11.7 million (as of 2021), your estate will not be subject to any taxation. In addition, by inheriting the property, your children will have a reduced amount of capital gains tax to pay should they decide to sell it.
Capital gains taxes are paid on the difference between what is known as the ‘basis’ in property, and its achieved selling price. When children inherit property, the tax basis for the property is stepped up. This means that the basis would become the property’s value at the time of death, as opposed to the original cost of the home.
There are, however, some disadvantages to this plan. Firstly, some states stipulate smaller estate tax exemptions than those at a federal level, so leaving the property in your will may result in your estate owing to the state taxes.
Secondly, if you utilized any Medicaid prior to passing, they may place a lien on your property, which could force it to be sold after your death in order to repay Medicaid.
Gift them the property
In any one year, when giving anyone other than a spouse any property valued over $15,000, or $30,000 per couple, you must lodge a gift tax form. However, you can gift as much as $11.7 million over the course of your life without being subject to any gift tax. So long as your property is worth less than $11.7 million, should you give it to your children, it’s unlikely that you will incur any gift taxes, but you will still need to file the gift tax form.
The downside of this option is that it can leave your children with the potentially steep consequences of capital gains tax if they are planning to sell the home. When a property is gifted, it is not eligible for the step-up in basis in the way that inherited properties are. When you give your property away, the original purchase price of the home becomes the recipient’s tax basis for the property.
Additionally, gifting property to your children can attract knock-on consequences should you apply for any Medicaid within five years of doing so. According to federal Medicaid law, if you transfer any assets within five years of applying for Medicaid, there will be a period of ineligibility to follow. This is called a ‘transfer penalty’ and the period of time will depend upon how much the gifted assets were worth.
Sell the property to them
You could opt to sell your house to your children. Should you sell your house for less than a fair market value, the difference between the sale price and the full market value would be considered as a gift.
As previously mentioned, you could then utilize the annual $15,000 gift tax exclusion, as well as the lifetime $11.7 million gift tax exemption to cover this gift amount. Regardless though, the same issues discussed above would then apply to this gift.
Another option to consider is selling the house at a full market value, but holding a note upon the property. This note should include interest and be put in writing. Then, you could use the $15,000 annual gift tax exclusion to gift your children $15,000 every year to assist them in making the repayments on the note. This setup can be complex and it is best to consult with an attorney to ensure that it won’t cause you any unforeseen tax complications.
Place the home in a trust
Another method of property transference is to place it into a trust. When you put a property in an irrevocable trust that has your children named as beneficiaries, it will no longer form part of your estate when you pass away. This will ensure that your estate will not be liable for any estate taxes relevant to the transfer, and the property will also be protected from any Medicaid estate recovery.
The issue here is that, once a property is placed in an irrevocable trust, it can never be taken out again. It can be sold, but the proceeds of the sale would still remain in the trust. You may also be subject to the Medicaid penalty period should you apply within five years of placing the property in the trust.
Determining the best way to pass your property onto your children depends largely upon your particular circumstances, and it’s important to seek legal advice when deciding which method will best suit your family.
*This article is based on personal suggestions and/or experiences and is for informational purposes only. This should not be used as professional advice. Please consult a professional where applicable.