Transferring property to your child? Here’s what to do

Q: My husband and I want to give or sell our house to our newly married daughter, who is our only child. She will inherit the house when we pass and receive the benefit of the stepped-up basis at that time, but we hope to be around for a while and don’t want her to have to wait until then! 

What strategy would you recommend that we investigate? We are not sure who we should talk to. Should we talk to a real estate attorney or a tax attorney?

Helping your child acquire their first home

A: You certainly can talk to a real estate attorney about the mechanics of transferring ownership of your home to your daughter and to a tax attorney about the income and capital gains tax implications of the transfer. 

But we want to share some of our thoughts about this topic, as we have recently received similar questions from other readers. It’s admirable when parents want to help their children financially, and they can do so without damaging their own retirement prospects. In particular, we like helping your children buy or acquire their first home, as this is an important step in creating generational wealth.

So, first, are you still living in the home? And, if you are moving, is the equity from this home relevant in any way to your future living situation or retirement prospects? If you still live in the home, why would you want to lose control over one of your largest assets and the one that gives you a roof over your head? 

Transferring property to your child as a gift

We also wonder whether your daughter wants to live in the home or sell it and use the proceeds to buy a house she really wants. If you’re no longer living in the home, and don’t need the equity to purchase your next property, gifting your daughter this house for her to raise a family is one thing. If she’s planning on selling and using the proceeds to buy something else, there may be better ways to structure a gift than signing over the deed.

Does your daughter want the house? If so, you can gift the property and file a gift tax return with the Internal Revenue Service. Your daughter would receive the property at the price you paid for it and not get the stepped-up basis. 

Assuming you’re set up for retirement (because if you’re not, you shouldn’t be giving away your largest asset), the next step is to figure out how to transfer ownership. You can give her the home in one transaction or sell it to her, hold back a mortgage, and then forgive a portion of the debt over time until she owns it free and clear. According to current tax law, you and your wife can forgive $17,000 each to anyone you choose. If you each forgive $17,000 of the loan to your daughter and her spouse, that’s $68,000 per year in debt forgiveness. After 10 years, assuming the IRS gift tax threshold stays the same, you could transfer $340,000 worth of value to her and the same amount to her spouse. 

Transferring property into a trust

What if you don’t really like her spouse? You could transfer the property into a trust and name your daughter the beneficiary of the trust. That way, the property would stay in her name. Your estate attorney or estate planner may have more sophisticated ways of managing the transfer that would have the maximum positive impact on your estate planning

What if your daughter doesn’t really want the property, but would rather have the cash? If you and your wife decide to sell, and have lived in the home for two of the past five years, the IRS allows you to keep profits up to $500,000 ($250,000 if you’re single) on the sale of your primary residence tax free. You could turn around and give your daughter the cash she needs to buy her new home. 

Transferring property to your child: Calculating property cost basis

Let’s get back to the stepped-up basis. It’s worth mentioning that IRS will expect to get paid if you have a profit on the sale of your home. From the IRS’ perspective, the profit is the difference between what the home cost you and what you got from the sale of the home. However, they allow you to add the cost of material and structural improvements (like an addition or roof replacement) that you may have made to the home and to include some of the costs of purchase and the costs of sale of the home. The term the IRS uses for the home’s cost to you is your basis, and we explain what that is in detail in this past column. 

How does this work? Let’s assume you paid $100,000 for the home and there were no improvements or costs of purchase. Your basis would be $100,000. If you sold the home for $500,000, your profit would be $400,000 (assuming no costs of sale). 

If you and your spouse hold onto the home until you both die, your daughter would inherit the home at its current market value around the time the last owner dies (you or your spouse). Your daughter would get the stepped up basis. If we assume the fair market value of the home at the time of the death of the final spouse was $700,000, your daughter would inherit the home at the $700,000 value. 

If you have an extraordinarily large profit on the property, it’s worth letting your daughter inherit it rather than paying any form of tax now. For more information, you should talk to an estate planner to help you with your needs and plan for your retirement.