You’ve decided to pass your home on to your children, but you haven’t settled on the best method to transfer ownership. You are also questioning whether you want to stay in the home or downsize to a smaller place. What factors should you be considering as you make your decision?
Start by reviewing the typical transfer paths that don’t involve inheritance. You can sell the house to your children, gift the house to them, or establish a trust (known as a Qualified Personal Residence Trust, or QPRT). Each path has financial ramifications for both you and your children.
Gifting the house requires you to file a gift tax form with the IRS, although you have the ability to use your unified federal estate gift/tax exemption amount to avoid tax if your house is below $5.49 million in value (based on 2017 rules). However, the cost basis on the home remains at your original sale price instead of being “stepped up” to full market value (as it is if you were to pass away and your children inherit the home).
If you bought the home many years ago, that could result in your children paying capital gains taxes on tens of thousands of dollars of appreciation if they sell the home soon after receipt. If they stay in the home for at least two years, they can take a one-time exclusion from capital gains taxes up to $250,000 ($500,000 for couples).
Gifting a home can drop the value of your estate and help you qualify for help with costs of long-term care – but be careful with your timing. There is a five-year “lookback” on assets, so if your gift occurs within five years of applying for Medicaid, the value is still counted against your assets when evaluating eligibility.
Selling the property to your kids at fair market value is straightforward, although if you plan to live in the house and rent it from your children, make sure that you rent at fair market value. Renting below market value may throw the tax status into question and cause problems with your children taking rental and property deductions.
Selling at a discount is acceptable, but the IRS will effectively consider the discount below fair market value as a gift, and will treat that portion accordingly for your gift exclusion and for capital gains purposes.
A QPRT seems to combine the best of both paths. With a QPRT, the home is placed in an irrevocable trust for a set number of years. You maintain a small “retained interest” but the overall value of the home is discounted for gift tax considerations. You can live in the home rent-free during that time. At the end of the QPRT, the remaining value of the home transfers to the beneficiaries. You can continue living in the home past the trust period by paying rent (assuming your children are willing, since they own the home at that point). The big risk is that you pass away before the QPRT expires, in which case the full value of the home is included in your estate.
Note that the lookback period applies to QPRTs as well as gifts, so if your goal is reducing assets, make sure that you execute your plan far enough in advance.
If you have an existing mortgage on the home, the above paths may be complicated. It’s possible that your lender will call in the loan balance rather than allow a simple transfer of ownership. In that case, your children may have to take out a loan at market rates and on their credit ratings — which may not be as good as yours. Discuss the options with your lender and make sure that their policies are compatible with your plans. MoneyTips is happy to help you get free refinance quotes from top lenders.
While your basic options are outlined above, there can be complicating factors, especially with options that involve selling to your children at a discount. It is a good idea to consult a real estate and/or elder law attorney with the experience to help you find the best path for your specific situation.
Whether your plans lead to a move to a lakefront bungalow, a new landlord who is a very close relative, or status quo with a trust for future transfer, take the time to consider all the financial and emotional factors, seek professional advice if necessary, clear your plan with all parties – and then forge ahead with confidence.
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