I am often asked by my (shall we say seasoned) clients about the wisdom of donating the family home to their children now. Usually, some family friend or one of the children has told the parents that this is a must and that they really should look into doing it as it will make things so much easier for the children when the parents pass.
While it is true that donating the home now will take the home out of the parents' estate, there are concerns that must be considered before doing so. After hearing the concerns, the clients usually agree that donating the family home is not the best idea for them. The concerns mostly deal with taxes.
First, if you donate the property to your children, you will lose the homestead exemption, which will greatly increase your property taxes.
The second concern deals with the concept of step-up in basis and how capital gains tax can come into play. For those who don't know, step-up in basis is a readjustment of value on inherited property. I will try to explain it by using a very simple example, and hopefully, will show you that donating the home is not always the right decision to make.
For our example, the premise is that Mom and Dad bought a home in 1980 for $100,000. Thus, their tax basis in the home is $100,000.
Let's say by 2012, the home has increased in value to $200,000. In 2012, Mom and Dad donate the home to their children.
Because it is a donation, the children do not get a step-up in basis. In other words, because the children are not inheriting the asset, the children’s basis is the same as Mom and Dad’s basis, which is valued at the time Mom and Dad bought the home back in 1980, namely $100,000, and not at the time of the donation in 2012. Thus, if the children sell the home for $200,000, they will pay a capital gains tax on $100,000, the amount above their tax basis.
Now, let’s change the example. Let’s say Mom and Dad do not donate the home to the children. They both die in 2012, still owning the home, and the home at the time of their death is now worth $200,000. The property is inherited by the chidren. Because the parents never donated the home to the children, the children (the heirs) get a step-up in basis to the value that the home has at the time of their parents’ death, namely $200,000. The new tax basis for the children is now $200,000 instead of $100,000. Thus, if the children sell the home for $200,000, there is -0- capital gains tax to pay.
Thus, taking these two concerns into consideration, the donation actually did not make things easier for the children, it actually caused a tax, which could have been avoided by not making the donation.
Now, after considering these concerns, if the client still wants to donate the property, there are some alternatives that can be looked into such as putting the home into a revocable trust to avoid the probate of the home thereof but still retaining all of the good tax benefits.
If you would like a more in depth explanation on any issue discussed herein, and in particular, the concept of step-up in basis, call us and we would be glad to discuss it with you.
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Many & LoCoco
Attorneys at Law
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