Keeping It All In The Family: Gifting Home Equity
By: Wells Fargo - April 11, 2018
Preserving family tradition and effective tax planning may not often intersect. But when gifting equity in a home to their children, parents may be able to accomplish both goals.
"One benefit is to give a home that may have sentimental value to someone in your family, as well as providing them with a place to live," says Matthew E. Brady, Senior Director of Planning for Wells Fargo Private Bank. "In addition," he says, "you're getting a valuable and appreciating asset out of the estate, which can have substantial estate tax savings."
Benefits of gifting equity
By giving equity in a home now, parents can pass along the gift at today's prices.
Options for completing a gift of equity
There are a number of gifting considerations, including potential capital gain issues in some types of transfers.
"If the parents have the liquidity, one option is to pay off the mortgage first. If the children will have some responsibility for the cost of the home, the parents could become the mortgage lender to their children for a portion of the home's value, thus deferring income tax consequences," Brady says.
But borrowing from the parents to finance the transfer would likely be taxed as a sale of the property to the extent of the mortgage, raising potential capital gain issues to the parents. Federal tax law (IRC § 121) permits a married couple to exclude up to $500,000 in gain from taxable income, but parents should be careful about any sale transaction.
Rather than paying down the mortgage, children might assume the mortgage as part of a gift. That also would bring up the sale issue; the Internal Revenue Service considers the parents as having accepted a partial payment for the property.
"That means the transaction is part-gift, part-sale, and there could be income tax consequences for the parent," Brady says. A $1 million house with a $300,000 mortgage, for example, is considered a gift of just $700,000.
To gift the house, but keep the mortgage, the parents need permission from the mortgage lender. (And, in the previous example, the value of the gift is $1 million if the mortgage stays with the parents.)
Take stock of the tax consequences
The value of the home's equity is subject to rules on gift and estate taxes. Based on the published amounts for 2017, each parent can give each child gifts of up to $14,000 per year without this counting against their lifetime exemption of $5.45 million. Amounts over that will be debited against the estate tax exemption.
"This is a compliance and tracking issue to make sure you're not giving too much away," Brady says. Fear of potential changes in the gift tax rules may lead parents to make substantial gifts to their children. "They may not have the full $5.45 million available to them anymore because they've used a big chunk of it," he adds. "They need to be very cognizant of that when they make future gifts."
There are other tax considerations: If parents gift home equity today, the children take the parents' original tax basis (plus any capital improvements). That may expose the children to possible larger capital gains taxes in some circumstances.
"There's always a trade-off between avoiding estate taxes and having to pay capital gains taxes," Brady says. "It's a lot closer call than it used to be."
Please consult your financial professionals including a tax advisor to determine which, if any, strategy is appropriate for your unique situation.
Article Source: Forbes
** Disclaimer Required by IRS Circular 230** Unless otherwise expressly approved in advance by the undersigned, any discussion of federal tax matters herein is not intended and cannot be used 1) to avoid penalties under the Federal tax laws, or 2) to promote, market or recommend to another party any transaction or tax-related matter addressed.