The Fiscal Cliff: Should You Give Your House to Your Children?

The fiscal cliff rapidly approaches and the gift-giving season is in full swing – even in multimillion dollar amounts. One of the benefits (admittedly to the wealthiest among us) that will go away at year-end is the $5.12 million gift-tax exemption ($10.24 million for couples). As of January 1st, it reverts to $1 million and $2 million, respectively. Most homeowners count their home as one of their most valuable possessions. Does it make sense to transfer ownership to your children now, to take advantage of the soon-to-expire exemption?

Is there time to gift a home?

In some states, transferring ownership can be as simple as having a document recorded by the County Recorder. You can sign the deed today and deliver it to City Hall yourself. You won’t get the recorded document back for a week or two, but today’s date is locked in and the property is effectively transferred to the new owner.

Obviously, you take some risks with this approach. If you plan to continue living in the home after you gift it, you may want to build some safeguards into the transaction.

Limited-liability companies and trusts are popular vehicles for ownership. When an LLC owns a property it’s not as marketable. That leads to a lower appraisal value, and as a result, a smaller piece of the lifetime gift-tax exemption pie. When a personal residential trust owns the property, the gifting parents retain control and the right to live in the home for however long they choose. This also has the effect of lowering the value and the amount that is applied to the lifetime gift-tax exemption.

You are not likely to be able to create one of these entities and successfully transfer your property to it before the end of the year. But according to the Wall Street Journal, some financial advisors can set up a trust in one day using other assets, preserving the 2012 date, with language that allows the asset to be swapped next year with the real estate to be gifted.

If you gift your home in a hurry, make a plan to take care of the details of control as soon as possible, and with the proper guidance from a qualified professional.

Should you give away your house?

Before you consider gifting your home, consider a few words of caution. For example, for the less wealthy among us, giving away your home could affect your eligibility for Medicaid or Medi-Cal.

Capital gains

If your family plans to sell the home, you could inadvertently stick your children with a very large capital gains tax bill at the time of sale. That’s because they’ll have to pay tax on the difference between what you paid for the house and what they receive for it at the time of sale. This could work out fine for anyone who paid at the top of the market or for someone who bought recently and has not seen great appreciation in value. But if you bought your cottage by the sea in 1985 for $105,000 and it’s worth ten times that much now, the capital gains liability will be based on $945,000. Ouch. Don’t worry about the tax if your family plans to keep the property indefinitely.

If your children inherit the home upon your death, the tax basis will be the current value rather than the original value. But they will of course be liable for estate taxes. Estate taxes are expected to rise to a much higher rate than capital gains taxes, so you’ll have to figure out which is less of a hit in your situation.

Standard of living

Don’t give away the maximum amount of assets to your own detriment. An immediate tax savings is nice, but only if you can afford to give the asset away. Remember to factor in your own current and future needs before parting with your home or any other valuable asset.

Other options

Other ways to give money tax-free are available.

    • Give your loved one $13k or forgive a loan (or portion) in the same amount
    • Pay tuition or medical expenses on behalf of a family member – write the checks now, even for next year’s expenses
    • Contribute to 529 accounts. The contributions are tax-free, and the withdrawals are, too, when used for tuition and qualified expenses. (Contributions do count toward the $13,000 limit.)

Happy gifting!