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Question
My parents have a home that they would like to pass down to me and my wife. We live in Orange County, CA, and our house has the following facts (in approximate figures):
Basis (Purchase Price): $250,000
Market Price Today: $480,000
Remaining Mortgage: $65,000
We want to know what is the best way to pass down this home with the least amount of tax consequences.
My parents are in their late 50s and are still relatively healthy. We are in our early 30s, so we still have time to really do anything. We just want to start out the planning process now.
Here are some additional facts:
-We are currently paying the mortgage payment of about $650 a month for the home.
-We own a small business that we operate out of the home. (We are wondering if this fact will allow us to do anything.)
-My parents do not live in the home. They are currently living in Japan.
We are considering the following options: 1. Will, 2. Trust, 3. Joint Tenancy, or 4. Some kind of buyout.
Thank you!
Submitted: 60 days and 5 hours ago.
Category: Tax
Value: $20
Status: CLOSED
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Optional Information
Country/State/Province of question: Orange County, CA
Already Tried:
This is my first option.
57 days and 15 hours ago.
Reply
Relist: No answer yet.
Posted by
Merlo
56 days and 9 hours ago.
Answer
Hello XXXXXXXXX,
The fact that you and your wife are the ones who are currently living in this home and paying the mortgage will have no effect at all on how this property eventually passes to you. And the fact that you use part of the home to operate a business also has no effect on how the home passes to you.
Basically your parents have 3 options for passing this home down to you:
1. Sell you the home
2. Give you the home as a gift
3. Leave you the home in their will
If they choose option 1, then your parents pay long term capital gains tax on any gain they have from the sale. If they sell to you for considerably less than the fair market value, then they are still considered as having given you a portion of the home as a gift.
If they give you the home as a gift, then your parents need to report the value of the gift given by filing Form 709. Under current law, each taxpayer is allowed a lifetime exemption on gifts of up to $1 million, so as long as your parents had not yet used up that lifetime exemption, then they would owe no gift tax, but they would be required to file this form. But by giving you this property as a gift, the drawback to that is the fact that you then retain the same basis in this property as your parents' basis. Your parents' basis would be whatever they originally paid for the property plus the cost of any improvements they made. If they paid $250,000 for the property and then added another $20,000 in improvements, their basis would be $270,000. That same basis now passes to you if they give you this property as a gift. So now when you sell the home, you would use this basis in figuring if you had any taxable gain.
If they choose option #3 and leave you this home in their will, then when you inherit the property you receive a full stepped up basis. What that means is that your basis in the home will the fair market value of the home on the day you inherit it. That is the basis you then use to determine your gain when you eventually sell the home. Since you indicated that the home has already gone up in value from $250,000 to $480,000, you can see how being able to use the current market value as your new basis will greatly reduce any gain you have at the time the home is sold.
If this was helpful please press the Accept button. Positive feedback is also appreciated.
Thank you XXXXXXXXX.
55 days and 23 hours ago.
Reply
Merlo, Thank you very much for your reply. It's very nice to have guidance on how to go forward with my situation. I wanted to clarify the tax consequences on the two of the above options that you provided me with. Here are my questions: 1. Will there be any tax consequences if we follow option #2 of gifting the house to us? My parents have not used up the $1 million exemption amount. Can I assume that the transfer of the property will occur tax free when using the gift method, i.e. no gift tax? 2. What kinds of tax consequences are there when they "will" the property to us? Are there any gift/death/inheritance tax that we must take into consideration? Thank you in advance for your time and considerations. Kind regards, Hiro
Accepted Answer
Hello again XXXXXXXXX,
I apologize for the delay in responding, but I had already left the forum last night by the time you posted this follow up question.
1. If the parents give you this home as a gift, then as long as they have not used up any of their $1 million lifetime exemption, they would not need to pay any gift taxes. However, the drawback to this option is what I pointed out in my original reply, and that is that when you receive property as a gift, you retain the same basis as the donor, whereas if you receive property through an inheritance, you receive a stepped up basis in the property. This will have an effect on any gain you have when you later sell this home.
As a simplified example, let's say that your parents paid $100,000 for this home and it is now worth $400,000. If they now give you this home as a gift, you retain the same basis of $100,000, even though the home is actually worth $400,000. Now if you sell it later on for $600,000, you have a taxable gain of $500,000. If instead you inherited this home and the market value was worth $400,000, then $400,000 is your new basis. Now if you later sell the home for $600,000 you only have a taxable gain of $200,000.
So while your parents may give you this home as a gift with no current tax consequences, you may have a higher tax situation down the road once you do sell this home.
2. If they leave this property to you in a will as part of their estate, then there are no inheritance taxes. Instead, the IRS imposes an estate tax on any estate which exceeds a certain value. That value is currently $3.5 million. So if something were to happen to your parents right now, as long as their entire estate did not exceed $3.5 million, then no estate taxes would be due. And you would receive the home at a stepped up basis equal to the current market value at the time they passed away.
If this was helpful please press the Accept button. Positive feedback is also appreciated.
Thank you XXXXXXXXX.
Expert:
Merlo
Pos. Feedback:
99.8 %
Accepts:
Answered:
9/28/2009
Accountant
25+ years tax consulting. Specializing in returns for US citizens living abroad
55 days and 8 hours ago.
Reply
Merlo, Thank you very much for your help! Hiro
Posted by
Merlo
55 days and 8 hours ago.
Answer
Thank you Hiro and let me know if you have more questions.
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