Giving your house to your children can have tax consequences, but there are ways to accomplish it tax-free. The best method to use will depend on your individual circumstances and needs.
Leave the house in your will
The simplest way to give your house to your children is to leave it to them in your will. As long as the total amount of your estate is under $5.45 million (in 2016), your estate will not pay estate taxes. In addition, when your children inherit property, it reduces the amount of capital gains taxes they will have to pay if they sell the property. Capital gains taxes are taxes paid on the difference between the “basis” in property and its selling price. If children inherit property, the property’s tax basis is “stepped up,” which means the basis would be the value of the property at the time of death, not the original cost of the property.
There are some downsides to this plan. Some states other than Virginia have a smaller estate tax exemption than the federal exemption, so leaving the property in your estate may cause your estate to owe the state taxes. Virginia has no estate tax. Also, if you were to need Medicaid at any time before you died, in some states Medicaid might put a lien on the property and the property might need to be sold after your death to repay Medicaid. Virginia’s Medicaid program does not impose liens on property, but it would have a right to assert an estate recovery claim against the property that a Medicaid recipient owned as of the time of his or her death. As a practical matter, very few Medicaid recipients in Virginia own property at the time of their deaths, since Virginia does not exempt the former home of a Medicaid recipient the way most other states do.
Gift the house
When you give anyone other than your spouse property valued at more than $14,000 ($28,000 per couple) in any one year, you have to file a gift tax form. But you can gift a total of $5.45 million (in 2016) over your lifetime without incurring a gift tax. If your residence is worth less than $5.45 million and you give it to your children, you probably won’t have to pay any gift taxes, but you will still have to file a gift tax form.
The downside of gifting property is that it can have capital gains tax consequences for your children. If your children are planning to sell the home, they will likely face steep capital gains taxes. When property is gifted it does not receive a step up in basis, as it is when it is inherited. When you give away your property, the tax basis (or the original cost) of the property for the giver becomes the tax basis for the recipient.
In addition, gifting a house to your children can have consequences if you apply for Medicaid within five years of the gift. Under federal Medicaid law, if you transfer assets within five years before applying for Medicaid, you will be ineligible for Medicaid for a period of time (called a transfer penalty), depending on how much the assets were worth.
Sell the house
You can also sell your house to your children. If you sell the house for less than fair market value, the difference in price between the full market value and the sale price will be considered a gift. As discussed above, you can use the $14,000 annual gift tax exclusion as well as the $5.45 million lifetime gift tax exemption on this gift. The same issues with gifts discussed above will apply to this gift.
Another option is to sell the house at full market value, but hold a note on the property. The note should be in writing and include interest. You can then use the annual $14,000 gift tax exclusion to gift your child $14,000 each year to help make the payments on the note. This can be tricky and you should consult with your attorney to make sure this won’t cause tax problems.
Put the house in a trust
Another method of transferring property is to put it into a trust. If you put it in an irrevocable trust that names your children as beneficiaries, it will no longer be a part of your estate when you die, so your estate will not pay any estate taxes on the transfer. The house will also not be subject to Medicaid estate recovery.
The downside is that once the house is in the irrevocable trust, it cannot be taken out again. Although it can be sold, the proceeds must remain in the trust. Similar to making a gift, if you apply for Medicaid within five years of transferring the house, you may be subject to a Medicaid penalty period.
Figuring out the best way to pass property to your children will depend on your individual circumstances. Talk to your elder law attorney to decide what method will work best for your family.