Q: My father owns a mortgage-free “summer” home in Virginia. Until recently, he spent most of his summers and occasional winter weekends at the house. The home is maintained by neighbors who are paid by my father for their services.
The house is part of his overall estate and the original intent was to sell the house at the time of his death and divide the proceeds between me and my sister.
But my father is now 94 years old and no longer wants the responsibility of being a homeowner. My sister and I suggested he keep the house in his name and we would assume responsibility for all costs to avoid any tax implications. He is insistent on not having any responsibilities for the home including having it in his name.
Is transferring the house to me and my sister an option and if it is, what are the tax implications?
A: Good question. If your father sells his summer home today, your father will have to pay taxes on any of the gains from the sale of the home. If his profits are large and he has owned the home for quite some time (long enough to qualify for long term capital gains treatment for the profits), he will have to pay up to 15 percent federal tax on those profits plus any applicable state capital gains tax.
If his profit is small on the property, and his actual income is low, he would pay much less in taxes to the federal government.
Estate Planning and Cost Basis
On the other hand, if he doesn’t sell the home and the home becomes part of his estate, you and your sister will inherit the home at the stepped up basis. That is to say, whatever the home is worth at the time of your father’s death, you would only pay tax on the appreciation that the home may have thereafter. Keep in mind that if you sell the home shortly after your father’s death, the value placed on the house for federal tax purposes will be the selling price.
Since the value of the house would be set at the price it was sold, there would be no federal income tax due under these circumstances.
Another issue to consider is whether the real estate market is strong where the summer home is located. If it is, you could decide that it is better to sell now and pay the taxes rather than risk that the real estate market might deteriorate in that area later on and get a lower price.
If the real estate market has soured where the home is located, you might want to keep the home with the hope that the market will improve down the line.
Living Trust Can Hold Home Title
If he does not want the responsibilities of the home and wants to feel like it is no longer titled in his name, you might want to talk to an estate planner and set up a living trust. The trust would hold title to the home, you and your sister could pay the expenses of the home and your father might feel like he has taken care of the asset now. Upon his death, the trust could transfer the home into your name and your sister’s name or you could have the trust sell the home.
Here’s another possibility: If the home used to be his primary residence and he used it as his primary residence for two of the last five years, he could sell it now and exclude from federal income taxes $250,000 ($500,000 if he were still married). But if it always was a second home, he can’t take the benefit of this exclusion.
Lastly, if the home was rented from time to time and your father took advantage of tax provisions that enabled him to depreciate the home over time and consider the home investment property, you might find that selling now will cause your father to pay additional federal income taxes.
You should sit down with an estate planner or estate attorney to go over all of the options available to you and your father now, while he is still able. At the same time, you can make sure his will is updated and that he has signed a power of attorney for health care and financial matters.
Jan. 19, 2009.