Don’t Give Them the House. Let Them Inherit It.
Many parents assume that giving a house to their children during their lifetime is a smart way to avoid probate or simplify their estate.
In reality, making a lifetime gift of appreciated real estate can create a significant tax problem for your children. In most cases, allowing your heirs to inherit the property instead of receiving it as a gift can save them tens or even hundreds of thousands of dollars in capital gains tax.
The Difference Is the Tax Basis
When you give someone a house during your lifetime, they generally receive your original tax basis in the property. This is called a carryover basis.
Example:
- You bought your home years ago for $150,000.
- Today it is worth $700,000.
- You give the house to your daughter.
Your daughter's tax basis is still $150,000. If she later sells the home for $700,000, she could owe capital gains tax on approximately $550,000 of gain, subject to any available exclusions.
What Happens If They Inherit the House?
When property is inherited, most assets receive a step-up in basis. The property's tax basis generally becomes its fair market value on the date of death (or an alternate valuation date if elected by the estate).
- Original purchase price: $150,000
- Value at death: $700,000
- Heir's new tax basis: approximately $700,000
If the property is sold shortly after inheritance for about that amount, there may be little or no taxable capital gain.
What About Probate?
Avoiding probate does not necessarily require giving away the property during your lifetime. Depending on your situation, alternatives may include:
- Revocable living trust
- Transfer-on-death deed (where available)
- Appropriate joint ownership arrangements
- Other estate planning techniques recommended by your attorney
Are There Exceptions?
Yes. There are situations where lifetime transfers make sense, including:
- Medicaid planning
- Asset protection planning
- Certain irrevocable trust strategies
- Other specialized estate planning situations
These decisions should always be made after considering both the legal and tax consequences.
The Bottom Line
One of the most expensive estate planning mistakes families make is giving appreciated real estate to children too soon. In many cases, allowing loved ones to inherit the property instead can provide a valuable step-up in basis and dramatically reduce future capital gains taxes.
Before transferring a home, vacation property, rental house, or other appreciated real estate, speak with both your CPA and your estate planning attorney. A simple planning decision today could save your family a substantial amount in taxes tomorrow.
Questions about gifting property or estate tax planning?
GurelCPA helps individuals and families understand the tax consequences of gifting, inheriting, and selling real estate so they can make informed financial decisions before transferring valuable assets.
The article is meant for informational purposes only. Please contact me directly to discuss how this applies to your individual tax situation.