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She can give it as a gift to her grandson.
Normally a person can give up to the annual exclusion amount $12000 for 2007 to a person, every year ($ 24000 in 2007 if spouses joins in for the gift) without facing any gift taxes and note that such amounts do not count as part of your $1,000,000 lifetime total.
Further, IRS allows a person to give up to $1,000,000 in gifts, total, in their lifetime, before they start owing the gift tax. (This gift is not per (donee)person but its a per donor limit). So you can make gifts that are worth up to a million bucks during your lifetime without paying the gift tax. . Even if you do not owe a gift tax because you have not reached the $1,000,000 limit, you are still required to file gift tax return if you made a gift that does not qualify as excludable.
Hence, if you mother has not used up her life time exclusion, she can gift the house to you without owing any gift tax. She will however, have to file a gift tax return and report the gift to the IRS.
Recipient of the gift also does not owe any gift tax.
Alternatively, she can also sell the house at fair market value and finance the sale. So she will carry a note and will receive monthly payments from the grandson. She can give gift every year to him upto the annual exclusion amount and he can pay the loan due to her. By doing this, your mother may not owe any tax as long as the gain on sale of the house is under $250,000 and she has owned and used the house as her primary residence for atleast 2 years in the 5 years preceding the sale. She will include interest that she gets on the note as income every year.
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Please note: This advice is provided with the understanding that all the relevant facts have been provided by you. Any change in facts might affect the advice given and hence may not be relied on in such cases. Nothing contained in this reply was intended or written to be used, can be used by any taxpayer, or may be relied upon or used by any taxpayer for the purposes of avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code of 1986, as amended.