You might be thinking that transferring ownership by gifting your house to your kids is a sound estate planning idea.
Maybe your home is the place you raised your family, a place that holds all your best life’s memories. It only makes sense that you want it to stay in the family.
Your home could be your most valuable asset, representing your legacy to your children. The last thing you would want to do is tie such an important asset up in probate.
Your home might be your nest egg. You want your kids to take control of it so, if the time comes that you need assisted living or nursing home care, they have an asset to leverage to pay for it.
Whatever the reason you are considering gifting your property to your children, talk to an estate planning attorney first because you could be making the biggest financial mistake of your life.
We see this all the time in our practice. Aging parents simply transfer ownership of the family home to their adult children — usually using a quitclaim deed — to easily give their kids rights to the home without needing to involve a real estate lawyer or pay expenses for things like a full title search. The parents usually continue to live in the home and, if there is still a mortgage, to make the mortgage payments.
The problem is that, in trying to save money and make the process simple, you can actually cost yourself much, much more due to loss of the tax advantages that come with the primary residence exclusion.
Under the IRS primary residence exclusion laws, as long as you have lived in your home for two out of the previous five years, currently you do not have to pay any capital gains tax on the first $500,000 of profit if you are married — and on the first $250,000 of profit if you are single — when you sell your home.
Very generally speaking, the profit is the difference between the sales price of the house and your basis in the house. The basis is calculated by taking the original purchase price of the house and adding in allowable amounts for improvements. You then deduct that amount from the sales price to calculate your profit.
So, let's say Mary and John bought their house in 1980 for $50,000. To make things easy, we'll assume they didn't make major improvements and there was no meaningful depreciation of the property's value, for tax purposes. Now, in 2018, the home is valued at $200,000. If Mary and John sell the home for $200,000, they have a profit of $150,000 ($200,000 minus $50,000). They will not pay capital gains tax on any of this profit because they lived in the home for two out of the previous five years and the profit is well under the $500,000 threshold for married couples.
Now consider, instead, if Mary and John had quitclaimed the home to their son, Mark, in 2016, when Mary started suffering from Parkinson's Disease. Anticipating that Mary might need nursing home care within a few years — and that John would downsize or move in with Mark and his family — they thought it would be easiest to simply give Mark the house. (Mark had taken on most of the responsibility for maintaining it, anyway — and, as a small business owner, they knew he would get a good deal when he sold the house, when that time came!)
Here's the problem: if Mark sells the home for $200,000 in 2018, he will not qualify for the primary residence exclusion come tax time because he did not live in the house for two of the previous five years. So the family, overall, will gain significantly less from the sale of John and Mary's home because Mark will have to pay capital gains taxes on the $150,000 profit from the sale. (For gifted property, the person receiving the gifted property effectively inherits the prior owners' basis in the property.)
It is also important to consider that, while everyone might be involved in the family decision to quitclaim property to the kids, circumstances can intervene that are not only unanticipated, but could be potentially disastrous. Take these examples:
There are numerous other tax and estate planning issues to consider prior to deciding whether gifting your house to the kids makes financial sense for you or your children. Careful planning and taking the time to understand all the potential consequences of your actions can make the difference between seeing your property used for the purposes you have in mind or losing this important asset to unintended consequences.
Luckily, there are great options that can usually achieve the results you're looking for — such as ensuring your house goes to your kids without a long probate process, and ensuring your kids can make decisions about your house if you become unable to do so — without the financial and other consequences that can come with simply deeding your home to your kids. For example, we often work with families to place a home in a trust initially controlled by the parent homeowners. The effect at first is that you keep all the rights and advantages of home ownership, just as when the home was titled in your name. The great advantage is that, when the time comes that you need your kids to take control of the asset, this can happen automatically.
Already deeded your house to your kids and are now having second thoughts? We have helped clients in this situation, too!
If you are located in Georgia, our estate planning and elder law professionals can help make sure you and your family make the best decisions about your home based on your own goals and needs. Call the offices of Asset Protection & Elder Law of Georgia at (770) 382-0984 or reach out to us online today.