Whether you're one of the many retirees opting to stay in your home and “age in place," or you're opting to downsize, there are a slew of pressing questions you'll need to resolve when it comes to how to deal with your home, which may be your most valuable asset.
If I leave the home in my estate, will my children be inheriting a large tax bill along with it? Can I afford to gift the home to my children who are eager to live the neighborhood? Should I sell, downsize and leave the cash for my children to divide?
While most parents want to be generous with their adult children and give equally to them all, decisions related to transferring property can be complex.
Before making any decisions about gifting your home, you need to factor your children's wants and needs into the equation.
“Before you decide to gift your home, you need to find out if your children want the home," said Alma Banuelos, National Head of Trust and Estate Services at City National Bank. “Do your kids children want to share the home with their siblings, and jointly make all the decisions related to the house?" Each child likely has different goals and financial needs, Banuelos noted, and sharing may not be easy.
“If the purpose of gifting your personal residence is to equalize your estate plan for your children, that's great. But it is important to ensure that if you are gifting it solely to one child over the others that the child actually wants it," she said. “Make sure the others don't want it, or that you are providing for the others in some fashion to offset this specific gift. Without due consideration, you may unknowingly cause additional friction for your family."
Gifting a personal residence often starts with an emotional reaction, when parents want to keep the home within the family rather than sell it, said Banuelos. Sometimes parents discover that their children don't want the property after all, which can simplify the planning process.
“The main advantage to not gifting your home and choosing to keep it in your estate is that your heirs could secure a tax advantage at your passing," said Banuelos. “Their cost basis will be increased to an amount equal to the value of the home as of your date of death — rather than keeping your basis (what you paid for it) — if it comes through your estate. This could mitigate capital gains taxes if they sell it later on."
Many considerations, such as the size of your estate, your reliance upon the sale proceeds for your on-going care/cashflow, and when you plan to move, prevent families from being able to gift a home during their lifetime.
If you're going to gift during your lifetime for one of those reasons, a key factor in your decision will likely be whether or not you or your children will be living in the home.
One of the reasons to consider gifting property during your lifetime is to reduce the amount of your taxable estate, said Banuelos. However, with the increased exemption amount, this may not play as large a factor as it did in the past.
While the lifetime gift and estate tax exemption is currently $11.4 million per person ($22.8 million for a married couple), high-net-worth families may want to remove assets from their estate to reduce the estate tax burden on their heirs.
If your goal is to reduce the size of your estate, you can apply the annual gift tax exclusion to a portion of the value of the home you're gifting. The annual gift tax exclusion in 2019 is $15,000 per person, which could total $60,000 if you and your spouse give to an adult child and his or her spouse. You can then apply the rest of your home's value to your lifetime tax exemption.
Another reason for gifting while living may simply be because your children want or are in need of the asset now.
For example, if your home is in a high-performing school district, your children may want to move into the house immediately in order to raise their family there.
In both scenarios, using a Qualified Personal Residence Trust (QPRT) may be the best strategy.
A QPRT transfers an interest in the property to a trust for your children but gives you control over the property. However, you or your children must live in it during the QPRT term.
“The term of a QPRT can vary, but you want it to be less than your life expectancy, because if you pass away while the property is in the QPRT the property goes back into your estate," said Cyndy Ranzau, a wealth strategist for RBC Wealth Management in Denver.
This is a great option for those planning well in advance because you can continue to live in the home for a few years, and the children don't have to move in once it's fully transferred if they don't want to.
However, a potential danger of gifting your property to your kids is that you give up control, Ranzau said.
“With a QPRT, once the term ends, you then have to rent the property from the trust if you want to stay in it," said Ranzau. “This can further help to reduce the value of your estate as the rent you pay is not counted as a gift to the trust or your children."
A more complex scenario occurs when you're ready to move and your children want to keep the house in the family, but they don't want to move into the home.
A QPRT wouldn't be the best option in this scenario.
The tax implications of gifting the house outright are an important aspect of your decision to gift during your lifetime, said Ranzau.
“While gifting your home so it is outside of your estate can reduce estate taxes, you could be giving your kids a potential income tax problem," Ranzau said. “When you gift assets to children, the cost basis on the assets for your children remains the same as it was for you – what you paid for the property plus any capital improvements and less any depreciation. If they receive the property through your estate, the cost basis is the fair market value of the property as of your date of death."
If you haven't owned the property long, the difference in cost basis may not matter as much compared to long-term ownership of a property that's significantly increased in value. For example, said Ranzau, a California waterfront property purchased decades ago for $100,000 could be worth $2 million today.
“Gifting that property outside of your estate could mean that your kids have to pay capital gains tax on $1.9 million when they eventually sell it, including possibly as much as 20 percent for federal taxes and 13.3 percent for California taxes," said Ranzau. “If they inherit the house through the estate when it's valued at $2 million and sell it right away, they would not to have to pay any capital gains tax."
Federal income tax rules state that as long as you have owned the property and lived in it for two of the previous five years, you can exclude up to $250,000 of profit from taxes if you file as a single taxpayer and up to $500,000 if you file jointly.
Depending on the difference between what you paid and what your home is worth now can determine if it's worthwhile for your family to sell the home today to take advantage of the up to $500,000 exclusion, or if your family will have to pay significant capital gains tax either way, in the case of the California waterfront example.
Of course, your family may want to keep the home and so the income tax is not an issue.
The key thing is to be aware of the various scenarios and how they could impact your wealth in the long-term before making an emotionally-driven decision.
While gifting your home may feel generous and give you peace of mind about what will happen to your home when you're gone, there are some potential disadvantages.
If you're thinking of gifting your personal residence to a family member, you'll need to work through a series of personal and financial considerations.
If you have multiple children, but you're only gifting the house to one of them, you have to ensure that you have enough assets in your estate to equally compensate the other children to avoid conflict and resentment.
Additionally, it's possible that all of the children want the home. If all of the children want the home to live in as their primary residence, rather than a shared vacation property, you'll have to find a way to give it to one of the children and compensate the others. If arrangements can't be made, your family may have to opt for selling the home to prevent further conflict.
Another plausible issue is the potential to transfer an asset to your kids children that you will later need for your on-going support.
“If the home was gifted out of your estate, unless the children agree to sell the home and return the proceeds, the parents have lost control of the asset," Banuelos said.
Ranzau also mentioned that even if the home represents a smaller portion of your net worth, the lifestyle you want in retirement could be a major factor in making the decision about whether to gift your property or not.
“One client gifted a beachfront property to their kids that had significantly increased in value, which was great for reducing the size of their estate," she said. “But they could have sold the property and used the money in retirement to fund their lifestyle, which was quickly draining their savings."
Families with higher net worth, such as a $5 million home and $5 million in marketable securities, are better suited to gift a property during their lifetime, said Ranzau, because they have enough assets to live on in retirement.
The last downside of gifting your property to your kids is that you give up control, Ranzau said.
As difficult as that may be to think about, parents need to plan and stress-test against every possible scenario.
“For example, you need to think about what could happen if you became estranged from your child and they tried to evict you," Ranzau said. “Your kid could develop a drug problem or a family problem of their own that could impact your ability to stay in the house."
Although these types of situations are extreme examples, having the means and a plan in place to ensure you're protected should they arise is an important aspect of your decision to gift while living.
Whether you choose to transfer or retain your current home when you downsize, consult your estate planner and tax advisor to compare the consequences of various options before you finalize your decision.
City National Bank's trust and estate team can help you weigh your options. To learn more, contact us.
This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.
City National, as a matter of policy, does not give tax, accounting, regulatory or legal advice. Rules in the areas of law, tax, and accounting are subject to change and open to varying interpretations and readers should seek professional advice.