Whether you have a split level or a log cabin, your estate plan should be considered when passing property along to the next generation. How you structure the transaction has legal and tax implications, explains the article “How estate planning can help you pass down a house to your kids and give them a financial leg up” from USA Today.
For one family, which had been rental property landlords for more than two decades, parents set up a revocable trust and directed the trustee to be responsible for liquidating houses only when they became vacant, otherwise maintaining them as rental properties as long as tenants were in good standing. They did this when the wife was pregnant with their first child, with the goal to maximize the value to their children as beneficiaries. This was a long-term strategy.
Taxes must always be considered. When a home or any capital asset is given to children while the parents are alive, there may be a capital gains tax issue. It’s possible for the carryover cost basis to lead to a big cost. However, using a revocable trust avoids probate and gives them a step-up in basis to avoid capital gains taxes.
Many families use a traditional method: gifting the house to the children. The parents retain the ownership and benefit of the property during their lifetimes. When the last parent dies, the children get the home and the benefit of the stepped-up basis. However, many estate planning attorneys prefer to have a house pass to the next generation through a revocable trust. It not only avoids probate but having a trust allows the parents to dictate exactly what is to be done with the house. For example, the trust can be used to direct what happens if only one child wants the house. The one who wants the house can have it, but not without buying out the other children’s’ shares.
If the children are added onto the deed of the house, keep in mind whoever is added to the deed has all the rights and liabilities of an owner. If one child wants to live in the home and the others don’t, the others won’t be able to sell the house. The revocable trust mentioned above provides more control.
Selling the family home to an adult child may work, especially if the parents cannot afford to maintain the home and the child can. However, there are pitfalls here, since the parents lose control of the home. An alternative might be to deed the property to the children, have the children refinance the property and cash the parents out.
If parents sell the home below fair market value, they are giving up proceeds to finance their retirement. If they don’t need the money, great, but if not, this is a bad financial move. There are also taxable gains consequences, if the home is sold for more than they paid. A home’s sale might result in a dramatic increase in property taxes to the buyer.
However you decide to pass the family home or other real estate property to children, the transfer needs to be aligned with the rest of your estate plan to avoid any unexpected costs or complications. Your estate planning attorney will be able to help determine the best way to do this, for now and for the future.
Reference: USA Today (Dec. 3, 2021) “How estate planning can help you pass down a house to your kids and give them a financial leg up”