Should I sell my house to my child or grandkids for $1?

July 08, 2020 by Carolyn Richardson, EA, MBA
House prices going up

It’s a tale as old as time. One of your children, or one of your grandchildren, heard how much money it cost to probate a friend’s parent’s estate and how long it took to sell the old homestead because of the probate court. They also hear from the friend of a friend that if you would just sell your house to them, then they don’t need to face probate when you are gone. But is this tax strategy a beauty or a beast?

Like most tax strategies, the answer is not simple. The reality is that you can sell your house to your child, grandchild, or anyone else for that matter, for $1. But just because you can doesn’t mean you should.

You might be thinking that selling your home to your child has no tax implications, but this is not true. A bargain sale like this would be considered a gift by the IRS, and the current gift tax exemption is $15,000 (if you are married, both you and your spouse can claim this exemption for a total of $30,000 gifted to one person). If you sell your home to your child for $1 when the home is worth $300,000, you have just gifted your child $299,999. And that will require a gift tax return to be filed. You can either pay the gift tax now or lower your lifetime estate exemption (currently $11,580,000). If your estate is close to the limit amount, you may wind up paying estate taxes anyway by lowering it now with a gift. Another problem is that while the estate tax exemption is currently quite high, it is scheduled to be reduced after 2025 back to the level it was in 2017 under the Tax Cuts and Jobs Act of 2017, so unless you die before 2025 (and who wants to die that quickly?) your estate may still be subject to taxes. And many states do not follow the IRS in this regard – some states have estate exemptions as low as $1,000,000.

And one other point regarding the estate or gift tax: if you continue to live in the house after the sale, and die while living in it, the IRS may disregard the gifting of the house to your child and continue to consider it part of your estate. So, these financial gymnastics may not have saved you any money at all.

However, the bigger issue beyond the gift tax return requirement is how it can impact your child’s taxes in the future when they decide to sell the home. When you gift your home to your child, your tax basis becomes their tax basis. What this means is that if you purchased your $300,000 home many years ago and paid only $50,000 for it, their basis for determining any gain or loss from selling it is now $50,000 rather than the fair market value it was when you gave it to them. That means they will have a $250,000 gain if they sell the house for $300,000. On the other hand, if you leave the house to your child as an inheritance, they will receive a “step-up” in the basis of the home to the fair market value on the date of your death. This means that rather than the $50,000 amount you paid for your property they now get to use that $300,000 value on the date of your death as their basis. If they sell the property for $300,000, they have no taxable gain. That certainly beats having to pay taxes on a $250,000 gain. If you live in an area where property values have increased dramatically since the home was originally purchased, and you have lived in your home for a long time, the savings for your child can be significant. For example, one taxpayer had a parent who had lived in Hawaii since 1965 and paid $24,000 for their home. The child recently sold the home for close to $1 million after their parent passed away. Because of the step-up in basis they received, there was no gain to pay taxes on. But, if that parent had sold the house to the child for $1, there would have been nearly a million dollars in taxable gain the child would have had to pay taxes on when they sold the home!

What if the house is now worth less than what you paid for it? Can you or they claim a loss on it? No, unfortunately that doesn’t work either. Because a sale to your child or grandchild would not be considered an “arm’s length” transaction, no loss on its sale could be claimed. Your child could not claim a loss on selling the property either, because the lower fair market value or what the child paid for the home would be used to determine the gain or loss.

One last thing to consider: if you sell your home to your child, they are now the legal owner of the house. That means they can do with the property what they please, including throwing you out of your own home! You would also not be able to obtain a reverse mortgage if you should need one, or refinance the property at all since you no longer own it.

Like many ideas that seem like a good idea at the time, this one needs to be carefully considered before you take the advice of a friend of a friend of your child. This beast is no Prince Charming in disguise, but a Big Bad Wolf.

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Carolyn Richardson, EA, MBA
Learning Content Managing Editor

 

Carolyn has been in the tax field since 1984, when she went to work at the IRS as a Revenue Agent. Carolyn taught many classes at the IRS on both tax law changes and new hire training. In 1990, she left the IRS for a position at CCH, where she was a developer on both the service bureau software and on the Prosystevm fx tax preparation software for nearly 17 years. After leaving CCH she worked at several Los Angeles-based CPA firms before starting at TaxAudit as an Audit Representative in 2009. Carolyn became the manager of the Education and Research Department in 2011, developing course materials for the company and overseeing the research requests. Currently, she is the Learning Content Managing Editor. 


 

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