If we deed our home to our children, but live in the house until our deaths, would the kids be taxed on the property or could we keep the exemptions even though the property has been deeded to the kids? Thank you.
A: We’re always worried when seniors decide to “deed” real estate to their children. There are several reasons why this is a bad idea, but tax implications are at the top of the list.
When you deed property to your children while you’re alive, you’re essentially giving them a gift. They receive that gift with the cost basis that you paid for the property.
So if you paid $10,000 for your house and it is now worth $200,000, and you give that gift to your children, they receive the house at the $10,000 cost basis. When they go to sell the property, they will pay taxes on the difference between the $10,000 cost basis and the sales price, which might be $200,000 or more, minus the costs of sale (like the real estate commission paid, if any).
If none of the children are living in the house as a primary residence, then none of the profit is sheltered, and they will pay taxes as if they had sold an investment, probably a long-term investment (but that depends on long they own the property before selling it). This will also have an impact on the total amount of tax they pay in a given year.
If your children inherit the property, they should receive the property at its fair market value the day of the death of the last owner of the property (unless the tax laws change again, and they might). So, let’s say you and your spouse die on the same day and your house is worth $200,000. Your children would inherit the property at $200,000. If they turn around and sell it the same day, they would owe no tax on the sale.
Also, if you “sell” the home to your children, you may no longer be eligible to receive real estate tax benefits that you otherwise would as a result of being a homeowner living in the property you own. You may also lose senior citizen tax breaks that are given to seniors in some parts of the country along with long term homeowner tax breaks as well.
It seems that the best idea is to create a will that leaves the property to your children. If you want them to avoid probate, you can create a simple trust, title the property in the name of the trust, and name your children as beneficiaries. That will allow the property to cleanly pass through probate, causing few problems and avoiding most costs.
For further reading, go to IRS.gov and look up Publication 551 Basis of Assets. There’s also a good explanation of the new estate tax rules at Nolo.com, which is a legal publishing site. (http://www.nolo.com/legal-encyclopedia/estate-tax-2011-tax-law-32263.html). To set up a trust, you will need a good estate attorney. If you don’t know an attorney, you can find one through your local bar association. Simply call and ask for the head of the estate attorneys committee and that person should be able to provide you with a few referrals.
Thanks for writing.