Q. I am thinking about just gifting my home to my son now, in order to minimize estate administration after I’m gone. Of course, I would continue to live here as long as possible. Do you see any downside to this plan?
A. Yes, there may be a big one, depending upon how you do it. Consider the following:
Taxes: Assuming that your home has appreciated substantially in value since you purchased it years ago, a simple gift of the home during your lifetimes would not be “tax smart”. An example may illustrate why:
Let’s suppose you bought the home years ago at a price of $75,000, but that it is now worth $775,000. To keep it simple, let’s also assume that you have not made any substantial improvements to the home. From a tax viewpoint, your tax basis in the home would be $75K, i.e. its cost. So, if you sold it now for $775 K, you would realize roughly $700K in gain. Even assuming you are eligible to exclude $250K of gain under the ‘sale of home residence’ exclusion, you would still realize $450K in capital gain upon which you would be taxed.
Likewise, if you gifted the home to your son during your lifetime, he would step into your shoes and would also then have a tax basis of $75K. If he later chose to sell, the home would generate a large potential tax liability for him. Whether he, too, would have the ‘home residence exclusion’ available to exclude some of the capital gain would depend upon whether he met the home residency tests before sale; if he used the home as a rental, that exclusion would likely not be available. In any event, his potential tax liability would be very substantial, and would likely increase over time as the home’s value increased, because it would continue to carry your older, low cost basis.
By contrast, if you passed the home to him as a result of your death, then under current tax law he would receive an adjusted tax basis equal to the home’s fair market value at the time of your death. Let’s suppose by then the home’s value has increased to $One Million. That would then be his new tax basis, and this adjusted basis would potentially save him tens of thousands of dollars in taxes if he later chose to sell the property.
So, trying to keep things simple now would potentially be very costly for your son down the road. That said, there are ways to ‘have your cake and eat it, too’: If you create a lifetime transfer now, but which is only complete at death, then you can both minimize estate hassle and achieve favorable tax treatment. One technique: use a Life Estate Deed, which preserves your right to occupy the home for your lifetime but gives him the ‘remainder interest’ after your demise.
Medi-Cal Subsidy for Long Term Care: If you believe that you may need long term care in the future, the home transfer should be handled in a manner that complies with the Medi-Cal rules, so as to preserve eligibility and to avoid a post-death reimbursement claim.
Child’s Credit Issues: If your son has unpaid creditors, you may wish to re-think your plan, as the home might then be exposed to his creditors’ claims.
Borrowing Unavailable: You would not be able to take out a conventional or Reverse Mortgage on your home to help with your expenses.
In your situation, it would be wise to consult with an attorney experienced in these matters before embarking upon your plan.