Don't just deed your house to your child
Category: Elder Law, Estate Planning, Tax Law and Planning
TimesDispatch.com MAIL BAG: Mom made a costly error in deeding house to child is an example of good intentions coupled with a lack of understanding of tax laws resulting in a large unexpected tax.
While the owner of their own primary residence enjoys an exemption from capital gains tax on the sale under IRC Section 121, a non-resident owner does not. See IRS Publication 523 for more information.
Here, mom gifted her house to son, and when he went to sell it to pay for mom's care, he found out that he owed capital gains tax on over $400,000 on the sale of the house. He (mistakenly) believed there was no tax on the sale of a home. He misunderstood that the tax exemption only applied (1) to his primary residence, not any residence he owned, and (2) only up to certain dollar limitations ($250,000 for a single person and $500,000 for a married couple).
This situation described in this article could have been avoided by considering several other alternative plan with the house such as:
- Mom selling house to son for a note - mom's sale is sheltered from tax through IRC Section 121, and son's basis in the house is the purchase price,
- Mom and son joining together to take out a home equity line so that she can keep the house but pay for her care,
- A reverse mortgage,
- A gift to son with mom retaining a life estate so she can always live in the house. The life estate would also include the house in her taxable estate, which in turn means that upon her death the son's basis is the fair market value at time of death (a "step-up" in basis under IRC Section 1014) - son can rent the house to generate income to pay for mom's care if she can no longer live at home.