Is your adult child struggling to buy a house? Here’s when it makes sense to offer them your home
You have an adult child who is struggling to buy a home in today’s overheated seller’s market. During this time, you are ready to unload your current abode. Maybe to downsize or move to a retirement community. Maybe to move to a warmer climate or a low-tax state. No matter. You are financially strong and don’t really need the money from selling your house. Hmmm. Here are some thoughts, which range from the ultra-generous to the practical.
Donate outright from home
Say you just gave your adult child your home. If you do this this year, it would reduce your unified federal gift and estate tax exemption by $12.06 million. To calculate the impact, reduce the FMV of the home you would donate by the annual federal gift tax exclusion, which is $16,000 for that year. The remainder is the amount that would reduce your unified federal exemption.
If you are married, your spouse receives a separate Unified Federal Exemption of $12.06 million. If you and your spouse jointly donate the home, each of your unified federal exemptions will be reduced. To calculate the impact, take half the FMV of the home minus the $16,000 annual exclusion. The remainder is the amount that would reduce your unified federal exemption. Ditto for your spouse’s separate exemption.
If your child is married and you give the house to your child and their spouse, you can claim a separate annual exclusion of $16,000 for your child’s spouse.
If you expect the house to continue to appreciate (apparently a good bet), removing it from your estate by gifting it is a good tax avoidance strategy.
Warning: Do do not donate the house outright if you intend to continue living there until the bitter end. In this scenario, expect the IRS to argue that the full FMV at the date of death of the home should be included in your estate for federal estate tax purposes, even if you were paying rent. fair to your child. Sources: CRI Sec. 2036 and Rev. Rule. 70-155 and 78-409.
Example 1: The current FMV of your home, owned by you and your spouse, is $750,000. You generously decide to make a joint gift of the property to your beloved unmarried daughter.
After subtracting two annual exclusions, the joint gift is valued at $718,000 ($750,000 – $32,000 for two exclusions) for federal gift tax purposes. So your unified federal exemption of $12.06 million is reduced by $359,000 (half of $718,000). Ditto for your spouse’s separate exemption. Neither you nor your spouse owe federal gift tax, as the gift is protected by your unified federal exemption. You and your spouse have exhausted some of your respective exemptions, but you still have plenty left.
As for your daughter, she takes on your presumed low tax base in the property, increasing the chances that she will owe Uncle Sam when the house is eventually sold for a gain. However, if she lives in the home for at least two years, she will qualify for the $250,000 exclusion of the federal single filer home sale gain.
Example 2: Now suppose your daughter is married and you and your spouse decide to make a joint gift of the house to your daughter and her spouse.
After subtracting four annual exclusions, the joint gift is valued at $686,000 ($750,000 – $64,000 for four exclusions) for federal gift tax purposes. So your unified federal exemption of $12.06 million is reduced by $343,000 (half of $686,000). Ditto for your spouse’s separate exemption. Neither you nor your spouse owe federal gift tax, as the gift is protected by your unified federal exemption. You and your spouse have exhausted some of your respective exemptions, but you still have plenty left.
As for your daughter and her spouse, they take over your presumed low tax base in the property, which increases the chances that they will owe the uncle when the house is finally sold for a gain. However, if they live in the home for at least two years, they will qualify for the $500,000 exclusion of the co-filer’s federal home sale gain. Pleasant!
Warning: If you’ve made substantial gifts in previous years, you may have already used up some of your $12.06 million unified federal gift and estate tax exemption. Ask your tax advisor about this.
Let’s say you decide to sell your house to your child for less than FMV. For federal tax purposes, you are considered to have donated the difference between the FMV and the bargain sale price. Source: CRI Sec. 2512(b). From a tax standpoint, this can be OK, as long as you understand what’s in store for everyone involved.
Example 3: You are unmarried and decide to sell your $750,000 residence to your single son for $250,000. In the eyes of the IRS, you donated $484,000 ($750,000 FMV minus $250,000 bargain sale price minus $16,000 annual gift tax exclusion). This reduces your $12.06 million unified federal gift and estate exemption by $484,000. Except in the unlikely event that you have already used up substantially all of your unified federal exemption by making substantial prior gifts, you will owe no federal gift tax.
What about the federal tax consequences of the discount sale for you? Good question. To calculate your taxable gain or loss, subtract the home’s tax base from the sale price of $250,000. Any loss is non-deductible. If you have a gain, it qualifies for the $250,000 federal single filer gain exclusion if you follow all the basic rules (you probably do).
Your son’s tax base in the house will only be $250,000. Thus, he will likely trigger a large gain when he sells the property. However, if he lives there for at least two years, he will qualify for his own $250,000 federal gain exclusion.
At the end of the line : These tax results are acceptable, but not optimal. Please continue reading.
Warning: Do do not make a profitable sale of your house if you intend to continue living there until you leave this cruel orb. In this scenario, the IRS can be expected to argue that the full FMV at the date of death of the home remains in your estate for federal estate tax purposes, even if you paid rent. fair to your child. Source: CRI Sec. 2036 and Rev. Ruls. 70-155 and 78-409.
Sale at full price with financing from you
Not comfortable with the idea of giving a big gift to your child looking for a home? I understand. So, let’s look at the alternative of selling the house to your child for the current FMV with you taking over a note for a large portion of the purchase price. When interest rates are low, such a vendor-financed arrangement will provide significant relief to your child while providing the best tax results for you and your child.
Example 4: You are married and decide to sell your residence for its FMV of $750,000 to your married son and his wife. The couple can manage a down payment of $150,000. You fund the remaining $600,000 by taking up a note for that amount. Assuming you’re feeling charitable, you can charge the lowest interest rate allowed by the IRS without any weird tax consequences. This is the applicable federal rate or AFR.
AFRs change monthly in response to bond market conditions and are generally well below commercial rates. At the time this was written, the long-term AFR, for loans over nine years old, was just 1.90% (assuming monthly compounding). The mid-term AFR, for loans over three years but not over nine years, was only 1.40% (assuming monthly compounding). At the time of writing, the going rate nationwide for a 30-year fixed-rate commercial mortgage was around 3.8%, while the rate for a 15-year loan was about 3.2%.
So you could pick up a 30-year note that charges long-term AFR of just 1.90%. Alternatively, you can pick up a nine-year note that charges a mid-term AFR of just 1.40%. Either arrangement would be a great deal for your son.
Now let’s move on to tax results. From a tax standpoint, you simply sold your home for $750,000. Assuming you qualify for the $500,000 federal gains exclusion on the sale of a home, you will likely owe little or no federal income tax on the transaction. Tax-wise, you are safe. There is no freebie, since you sold the house for FMV. From a tax perspective, the sale removes any future appreciation in the value of the home from your taxable estate. Obviously, these are all good tax results for you.
On your son’s side, his tax base in the house is $750,000. If he and his wife live there for at least two years, they will be eligible for the exclusion of $500,000 of the gain from the sale of the co-filer’s home, which should entirely house any gain unless the home fails. appreciate very substantially.
If you wish, you can financially retire your son after the sale by making annual cash gifts to him under the annual gift tax exclusion lien of $16,000, or $32,000 if you and your spouse makes joint gifts to your son ($2 x $16,000), or a whopping $64,000 if you and your spouse generously make joint gifts to your son and his spouse ($4 x $16,000). However, do not give indirect gifts in the form of accepting reduced payments or no payment on the bill owed to you. This would invite the IRS to recast the entire arrangement as a discount sale of your home, with the suboptimal tax consequences explained in Example 3.
Key point: You must go through the legal process of securing the note owed to you with the house. Otherwise, your son will not be able to treat the interest paid to you as deductible qualifying residence interest. If the remark is do not secured by the property, interest payments will be treated as non-deductible personal interest.
The bottom line
Here is. Some potential solutions to your adult child’s home-buying challenges in today’s crazy real estate market, with resulting federal tax consequences.