Family Property Transfer – What You Need to Know…
Real estate transfers are common among family members. Whether it’s out of the goodness of your heart or a part of an estate planning strategy, these transactions happen for a number of reasons. While property transfers can be useful to accomplish a particular goal, not all taxpayers consider the tax consequences.
There are other non-tax related issues that should be considered before attempting the property transfer by deed, will, or trust. For example, if the property is secured by a mortgage, the remaining balance may become immediately due when ownership changes. If you are considering employing any of these strategies, talk to an attorney licensed in your state with expertise in real property transfers.
Thus, here are common property transfer scenarios between family members and the respective tax implications:
Family Property Transfer: Adding a Joint Owner
You add another family member to the deed as a joint owner of your home so that it will pass to them automatically upon your death.
So, what are the tax implications of this? Adding a family member to the deed as a joint owner for no consideration is considered a gift of 50% of the property’s fair market value for tax purposes. If the value of the gift exceeds the annual exclusion limit ($14,000 for 2016) the donor will need to file a gift tax return (Form 709) to report the transfer. However, they will not likely owe gift tax due to the unified gift and estate tax exemption, which is currently more than $5.4 million. Additionally, each owner will have a basis in their respective ownership interests equal to 50% donor’s basis on the date of the transfer.
When one of the owners dies, the decedent’s personal representative must include the fair market value of the decedent’s ownership interest in the gross estate for estate tax purposes. The surviving owner receives the decedent’s ownership interest with a stepped-up basis equal to the inherited property’s fair market value (generally the same amount included in the decedent’s gross estate). The surviving owner combines the stepped-up basis in the inherited portion with the basis received at the time of the gift to determine their total adjusted basis in the entire property. Basis is used to determine gain or loss when the home is later sold.
Note that adding a family member to the deed while retaining a right to use the home exclusively for the rest of your life has different tax consequences. Such a situation results in the creation of a life estate, which is discussed next.
Family Property Transfer: Gifting Real Estate
You give a piece of real estate property directly to your child or grandchild.
If you give a plot of land to your child or grandchild, it’s considered a gift in the eyes of the IRS. Gifts of real estate to your child are not tax deductible. You can’t claim a loss, even if the paperwork shows you sold the property for $1 or another nominal amount. So the tax issues are all in the nature of expenditures, not savings.
For example, if you gift land worth $500,000 and you do not receive anything of that value in return, there are tax implications for the donor. As of 2016, the IRS allows you to give $14,000 annually to anyone you like, tax-free. If you’re married, you and your spouse can each give $14,000. However, if the value of the gift exceeds the annual exclusion amount, you, as the donor, must file a gift tax return (Form 709) to report the gift. As discussed earlier, you will not likely owe any gift tax if you have not yet used up your unified gift and estate tax exemption.
While you may think you can fly under the radar with real estate transactions, this is not the case. Do your research on property transfers so you can plan ahead from a tax perspective.