When transferring rental property to your child, is it better to sell it to them or leave it to them in a will? Both ways have their advantages and disadvantages.
Q: First, I always enjoy reading your advice column in the Torrance CA Daily Breeze home guide magazine.
Your article today, “Selling a rental property without facing a large tax bite” replies to an elderly couple who want to sell a single family rental home to their son and his wife. We can assume the son and his wife would like to live in the property. We further can assume the parents want to continue receiving some sort of income or lump sum amount (this need might be implied by their mention of “reverse mortgage”).
All the information you provided is good, but you did not mention what I consider might be best: simply rent the property to the young couple and let them know that the property is willed to them via their will and living trust.
This has several great advantages that your suggestions do not. First, there are no taxes for the estate to pay. Second, there is no tax due to the young couple when they receive their inheritance (assuming the stepped-up value law remains). Third, the son is incentivized to maintain the property just as though he owned it. Forth, the parents continue to receive income they are accustomed to and may depend on.
I have purchased and sold income properties for 40 years as an investor, many of them by using a 1031 exchange. I would never consider actually selling my son a property I own, as long as the stepped-up value IRS code remains available.
A: Thank you for your comment. Yes, your idea about how to transfer property to a child is a good one. The kids in this family might like that idea as well, but when we make assumptions in our answers we can’t always go through all the permutations. We appreciate your suggestion and are sure some of our other readers may as well.
One thing you mentioned was the stepped-up basis. We wanted to explain that concept in a bit more detail.
When you own a home and own it for some time, you usually have purchased it for a price that is substantially lower than what it may now be worth. Under current law, if you purchased a home for $50,000 and years later when you die the property is worth $1,000,000, your heirs will receive the home at its value at the time of your death.
Your estate wouldn’t pay capital gains taxes as a result of the appreciation and your heirs wouldn’t only pay taxes on the profit over $1,000,000.
Given all of this, there are times that your suggestion is by far the better solution. If there is little profit in the sale, the parents may not care about paying it and the kids may benefit from owning the property sooner and getting the real estate tax and interest deductions on their federal income taxes.
There are quite a number of moving parts to most letters like the ones we answer. Thanks providing some detail on another facet.