If you are considering giving your home to your children, bear in mind these cost-effective options for passing on property. There are a few methods for transferring property; depending on your situation and end-goals, you can determine which option works best for you.
Leaving the House in Your Will
The go-to method for passing your home to your children is to leave it to them in your will. By allowing them to inherit the property, your children will pay fewer capital gain taxes if they choose to sell the house. Capital gains taxes are imposed on the profit resulting from the sale of the home. Since the home is usually worth more by the time it is inherited by your children, this difference can be significant. However, on inherited property, the capital gains tax is only applied to the difference, rather than to the entirety of the home’s current value. Estate taxes can also be avoided when inheriting a property, so long as the property is valued under $5.45 million as of 2016.
On the downside, leaving your property in your estate could result in state taxes because some states have smaller state exemptions than federal. Also, those with Medicaid should be cautious of this option. If you owe for Medicaid at the time of your death, Medicaid may put a lien on your property to use the property value to repay what you owe.
Gifting the House
By law, it is permissible to gift up to $5.45 million over your lifetime without incurring a gift tax. If your home is valued at the allowed price or less, you may gift it to your children. As a rule, if you are gifting property valued at more than $14,000 in any one year, you must file a gift tax form, unless the recipient is your spouse. Keep in mind, this price applies to individuals. If a couple gifts a property, the value must be over $28,000 to require a gift tax form.
However, there can be pricy downsides to gifting a property. For example, if your children decide to sell the home, capital gains tax could be more costly. When the property is gifted, the capital gains tax is applied to the original cost of the property. Also, if you apply for Medicaid within 5 years of gifting the house, you could be ineligible for Medicaid for a period of time. The severity of this forfeit, called a transfer penalty, depends on the value of the property.
Selling the House
Another option is to sell your house to your children. If you sell your home under market value, the difference between the purchase price and the value of the home would be considered a gift. As mentioned before, gifts may not exceed $5.45 million over a lifetime or $14,000 annually, so consider these numbers carefully.
You could also sell your home to your children at full value, and “hold a note” or “hold the mortgage” to leave them the money to pay for the property. You could use the annual gift tax exclusion towards this, but always remember to include interest. Consult your attorney to ensure this will not cause any tax problems.
Putting the House in a Trust
If you choose to put your house in an irrevocable trust that names your children as the beneficiaries, the property will no longer be part of your estate when you die. By removing it, there will be no estate taxes charged in the transfer and the property will not be subject to Medicaid estate recovery.
However, once the house is in an irrevocable trust, it must remain there. If the property is sold, all of the proceeds from the sale must be kept in the trust. If you apply for Medicaid within 5 years of putting the house in the trust, it could be subject to a penalty period.
Each of these possibilities has upsides and downsides, but when deciding how to leave your home to your children, remember to consider the best benefit to you and your family. Always consult your attorney to discuss how these options work with your financial situation.