It is not uncommon for parents to want to give a child a house or apartment. It might be that the parents are moving to a retirement home and no longer need their residence. On the other hand, it might be that they have accumulated multiple properties over the years and want to remove the properties from their estate to save on estate tax or want to qualify for Medicaid. Whatever the reason, it is important to be mindful of capital gains tax and how it can affect income taxes.
Capital Gains Tax
When a parent gives a child real estate while the parent is still alive, the parent passes the original cost basis of the property to the child. The cost basis is the purchase price the parent paid for the property. When the child eventually sells the property, any profit over the cost basis is subject to capital gains tax. For example, let's say a parent purchases a house decades ago for $200,000 and with appreciation the house is now worth $1,000,000. If the parent gives the property to the child, the cost basis passed to the child is $200,000. Now, if the child were to sell the property a year later (considered a long-term capital gain), the full $800,000 profit would be subject to capital gains tax unless the child qualifies for an exemption (i.e. home sales exclusion), which will reduce the amount subject to the tax. Assuming a 15% tax rate (singles with incomes between $41,675 and $459,750 in 2022), the child would owe $120,000. If the child were to sell the property in less than a year from owning it, which is considered a short-term capital gain, the tax rate can be even higher.
Stepped-Up Basis
In order to save on capital gains tax, it would be wise to give the house as an inheritance in a will or trust. A trust is a more seamless option, however, as it allows for the expeditious transfer of property whereas wills must go through probate. Giving the house as an inheritance upon death, allows the house to have a stepped-up cost basis, which is the fair market value at death and in certain circumstances, the value six months later, whichever is more favorable. With a stepped-up basis, the house worth $1,000,000 at death would have a cost basis of $1,000,000 instead of the original cost basis of $200,000. If the child were to sell the property for $1,000,000, no capital gains tax would be owed.
Other Considerations
While there are other considerations such as estate tax or Medicaid planning that might make giving a house to your child during your lifetime a good idea, it is wise to be mindful of the potential adverse income tax consequences of doing so. It is also worth noting that another consequence of giving a house to your child during your lifetime is a reduction in your unified gift/estate tax credit by the amount of the gift. Consult your financial professional and your estate planning attorney to see what's right for you.
This article is a service of the Law Office of Keoni Souza, LLC, an estate planning law firm in Honolulu, Hawaii. We don’t just draft documents; we ensure you make informed and empowered decisions about life and death, for yourself and the people you love. That's why we offer a Family Wealth Planning Session, during which you will get more financially organized than you’ve ever been before, and make all the best choices for the people you love. You can begin by contacting our office today to schedule a Family Wealth Planning Session and mention this article to find out how to get this $750 session at no charge.
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