There can be many personal and tax benefits for families who choose to give the gift of home ownership.
Preserving family tradition and effective tax planning may not often intersect. When parents gift a home with equity to their children, however, they may be able to accomplish both preservation of the home for future generations and potential tax savings by moving a valuable and potentially appreciating asset out of the estate.
Consider a scenario where parents own a home valued at $1 million and intend to include it as part of their estate. If the home continues to grow in value — for example, from $1 million to $2 million over the parents’ remaining lives — that $2 million figure would increase the likelihood that the value of the parents’ estate would exceed the estate tax exclusion.1
Potential tax implications
Staying aware of your lifetime gifting is important. The value of the home’s equity is subject to rules on gift and estate taxes. Each parent can give each child up to $16,000 per year in 2022 without this counting against their lifetime exclusion. Amounts over that will be debited against the federal estate tax exclusion, which currently is $12.06 million. 1
“With potential changes in the gift and estate tax rules in 2026, many parents may consider substantial gifts to their children before then as they may not have the full $12.06 million available for future gifts,” says Greg Miller, lead financial planning consultant, with Wells Fargo Wealth & Investment Management.
There are other tax consequences to consider. If parents gift a home with equity today, the children take the parents’ original tax cost basis (plus any capital improvements). While a lifetime gift transfers equity to the children sooner, it may expose them to possible larger capital gains taxes in a future sale.
If the house were instead passed to children as part of an estate, the children would receive a “step-up” basis, resetting basis at the market value on the date of the second parent’s death. With a step-up in basis, the children would likely pay less capital gains tax when the house is sold than if the house were gifted prior to death.
“There’s always a trade-off between avoiding estate taxes and having to pay capital gains taxes,” Miller says. “Currently, the top federal estate tax rate is 40%. Depending on where you live, the capital gains rate can be more substantial.”
If the parents pay the mortgage first
If they have the liquidity, parents may choose to pay off the mortgage before gifting a home with equity.
Making the gift to more than one child can create a tenancy-in-common situation where the children share ownership and management of the property. Such arrangements should be thoroughly discussed among the parties involved.
Some parents may want to create financial responsibility with the gift by becoming mortgage lender to their children for a portion of the home’s value. Since this likely would be taxed as a sale of the property to the extent of the mortgage, parents should discuss any potential capital gain issues with their tax advisor first.
If the parents do not pay the mortgage first
Another option is for children to assume the mortgage with the gifted home. The Internal Revenue Service considers this as the parents accepting a partial payment for the property.
“The transaction could be considered part-gift/part-sale,” Miller says. “A $1 million house with a $300,000 mortgage, for example, is considered a gift of just $700,000.”
If the children wish to assume the mortgage, the lender will have to consent to the arrangement.
If the parents want to stay in the home after the gift
By placing the home into a Qualified Personal Residence Trust with the children as beneficiaries, parents can reserve the right to live there for a stated term —15 years, for example. The value of the reported gift is measured at the time the home is gifted into the trust, not when the children move in years later. The home may appreciate in value significantly before the children receive it.
“Even if the house triples in value, it’s out of the estate and there’s no further gift amount applied to the lifetime exemption,” Miller says. “However, if the parents do not survive the term of the trust, the estate is taxed as if they never made the gift.”
The estate/gift exclusion and generation-skipping transfer (GST) exemption are subject to a cut in 2026. Be sure to stay connected with your financial professionals and legal and tax advisors.
“With so many complex factors at play, it is important to understand both family and tax implications of your gifting strategy,” says Miller. “Your advisors with Wells Fargo Wealth & Investment Management can help you work through the dynamics to determine the best path for gifting your home and other assets.”
- The estate/gift exclusion and generation-skipping transfer (GST) exemption are currently slated to increase by a cost-of-living adjustment every year but are subject to a cut in 2026. As of May 13, 2022, the estate tax and GST lifetime exemption is $12.06 million limit per taxpayer, and the gift tax annual exclusion is $16,000. https://www.irs.gov/businesses/small-businesses-self-employed/estate-and-gift-taxes
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