Ways to Let Your Kids Inherit Your House Tax-Free
- April 7, 2022
- by Michael
As parents, you want to secure your children's future after you pass on. When it comes to property and cash large sums of money can be involved. A common mistake is to ignore factors like inheritance traps, taxes, and probate. Poor planning can result in surprise tax bills and squabbles between siblings (and their spouses) over the inheritance.
When it comes to passing on inheritance, there are ways to do it tax-free. Specific tools, like a gift asset, a trust, or a will goes a long way in helping your heir avoid taxes. You can even sell the house to your children for a value much less than its actual price. All of these will make the transfer of property hassle-free for your children.
Now, there may be a lot of ways to give your house to your children tax-free, but the choice will depend on individual circumstances. So, it is wise to plan much ahead and consider all viable options before making the call. This isn’t something you can do on your own. You will need to consult with an estate planning lawyer and your tax accountant to make sure it goes according to plan based on the laws in your area. In this article, you will find a few common strategies to consider.
1) Keep the House Under Your Name
When looking for ways to transfer your home tax-free to your child, you want to avoid paying capital gains tax on all appreciated value. For this, you might want to keep the house under your name unless you plan on moving out.
This applies to any estate within the boundaries of the unified federal estate gift and estate tax exemption amount, which is currently about $12 mill. In other words, if the estate is under $12 million the inheritance will be tax free.
Compared to gifting the house to your children, this is a better accommodation as it allows you to live there. Even if you continued to stay after giving and paying rent to your child, the IRS would still consider the fair market date-of-death estate valuation to be taxable. It is a good tactic because it lets your heirs move into the house without additional taxes.
2) Setup a Trust
Another strategy to avoid the estate taxes is to put the house into an irrevocable trust. In this transfer method, the process is final. It means that the property will cease to be a part of your estate after your death. This way, the home is factored out of your estate ahead of time. Typically your children are named as beneficiaries of the trust.
Putting the house in a trust protects the home from any estate recovery process even after your death. The only downside to the approach is that shifting to the trust is not reversible. Sure, your children can sell the house in the future, but the proceeds from that will remain in the trust.
3) Gift the Asset
Giving the house to your children is an excellent method of tax evasion as well. However, you should only do so if you plan on moving out. In that case, you can transfer the property as a gift.
You can give up to $15,000 as a gift annually and you will not be taxed. In addition, you can give up to approximately $12 million to a person over your lifetime before the gift tax kicks in. If you are in the lucky position to be able to give some more than the gift tax lifetime limit, the giver pays any tax, not the person receiving the gift.
If you give someone more than $15,000 in a year, the IRS requires you to complete a gift tax form to track the excess amount. For married couples, the limits are much higher.
The major downside to giving the property as a gift to your child is long term capital gains. Their basis (what they paid for it) will be well below fair market value. That can translate into a capital gains tax hit when they go to sell the property.
Another drawback is if there are multiple children involved and their names are on the title the property sale can be held up indefinitely while they fight over what happens to it… One party may want to move in, other parties may want to sell, and it could get caught up in divorce proceedings. Ugly stuff!
4) Sell Directly
You can sell your property directly to your heirs (children or grandchildren) without interference from the IRS.
This allows you to:
- Sell to your children/grandchildren for less than fair market value
- Use the difference under the annual gift exclusion
When you sell a property to a relative like this, the difference between the sale price and the fair market value is considered a gift. However the same exemption limits apply as above, so unless the home is worth more than $12M there will not be any taxes.
5) Leave the House to your Children In a Will
Perhaps the simplest option you have is leaving the house to your children in your will. All you need to ensure is that the estate value does not exceed the lifetime gift exemption limit of $12 million per.. This also avoids the capital gains tax considerations for your children.
Going with a will makes it easier for them to sell the property in the future. The only problem with this strategy is that the tax exemption in certain states may be lower than the federal exemption. So, your heirs may still have to pay some state taxes.
6) Qualified Personal Residence Trusts
If you want to avoid the taxes on your estate and still live in your home, a qualified personal residence trust or QPRT is worth considering. When you use a QPRT, it simply removes your residence from the taxable estate status without you having to move out. Even if you have sold the property to your children at less than fair market value, this is applicable.
The QPRT is a type of irrevocable trust that is terminated within a stipulated duration. When the trust's duration is completed, if you still live in the property, you can choose to pay rent to your children. The only risk involved is sharing a terrible relationship with them as they can throw you out.
A small catch to this strategy is that you have to outlive the terms of the trust. If you die before the trust's expiry, then the total date-of-death value adds up to the tax, and your children get no tax benefits.
7) Add Your Children to the Title
Adding your child to the title of your home sets up a situation called joint tenancy where they share in the ownership of the home. This is a seemingly good tactic to transfer your home to your children. Since there are no defined property shareholders, when you die, the remaining share automatically gets transferred to the heirs via survivorship. The property automatically avoid estate probate in this scenario.
However, when you add your children to the title while you are still alive, they inherit the basis of the property. Also, there will be a capital gains tax based on the difference between the basis and final selling price of the estate.
Some drawbacks are, if there were ever any dispute or legal proceeding, the house could become subject to the creditor claims. Also, if your child has a divorce, the ex-spouse can claim a share of the property since the court requires equitable division. The complication increases if you have multiple children and add everyone’s name as co-owners.
A property transfer can be a complex matter that involves various legal concerns. By calculating all the pros and cons of the methods mentioned, you can choose a way that works for you.
Consult a legal practitioner to discuss which option is best for you. Once you figure out which method works best for you, you can pass the property to your children without worries.