I get many questions about the tax consequences of parents adding their children’s names to the deed, or parents removing their names and give the entire property to their children. In the interest of time, I will summarize the various issues below:
1. The mechanics of transferring title
Taking names off a title deed and adding names to a title deed are relatively easy: the current owners can simply use a “Quit Claim Deed” or a “Grant Deed” to relinquish their ownership claim, and add whoever they want onto the deed as new owners or co-owners. The owners’ signatures have to be notarized, and then the deed needs to be recorded at the County’s Recorder Office. A Preliminary Change of Ownership Report (PCOR), which can be downloaded from the County Recorder’s website, must be submitted at the same time.
Although you can download (click on http://www.lawca.com/noforms/R0782.html ) or buy a blank deed form from places like Staples or Office Max, and complete it yourself, it is better for someone experienced to help you. Usually in a real estate transaction the escrow officer at a title company will be the one to do this. But because this is not a loan transaction title companies may not want to do this for you. But you can ask someone who has had real estate experience, or banking experience, to help you. If you can’t find any one, you will have to find either a service company (some notary public can do this) or a lawyer to help you. Because this is a legal document that affects the title to your home, everything has to be perfect on it.
2. Gift Tax Issues
If the current owners are not paid based on the market value of the property, then it is considered a “gift” from the current owners (parents) to the children. Since each person can only gift each year up to $15,000 in value to another person and avoid paying gift tax and reporting to the IRS, this gift will most likely exceed $15,000.
The value of the gift is determined by an appraisal on the property around the time of transfer, minus any bank loan. Let’s say if the market value of the property is $300,000 and there is a $100,000 mortgage loan on it. If the owner transfers title to his child, he will be gifting $200,000 in value to his child. If the property is in the names of two parents, then each parent is gifting to the child $100,000 in value. If the child is married, then the parents are each gifting $50,000 to the son and the daughter-in-law. As in each case the gift has exceeded the $15,000 annual gift limit, there will be gift tax issue to consider. Gift tax is always the givers’ concern, not the recipients’ concern.
Instead of paying gift tax on the excess portion, usually one would choose to offset this excess portion with the personal lifetime estate exemption of $11 million per person. In the above examples, the parents need to determine the value of the gift by having an appraisal done in order to determine the value of the property. And then each parent would file Form 709 (same deadline as their tax return, but the Form 709 is sent separately to IRS Center, Cincinnati, OH 45999) to report the gift to the IRS and to elect to have the excess gift amount deducted from the personal estate exemption amount. Currently each person has $11 million in estate exemption, of which the IRS allows the entire $11 million to be used during one’s life time to offset any excess gifts.
You can either complete the Form 709 yourself, or ask their accountant to help. It goes something like this: if the appraisal shows the house is worth $300K, and there is a bank loan of $100K on it, the net value of the house is $200K. Assuming the property is currently in the name of the parents. When they quit claim, each of them is gifting to the son $100K in value. Because $15K is free from gift tax, the excess amount for each of them is $88K. In their Form 709, each of them will use a portion of their estate exemption to “shield” the excess gift amount from any gift tax. Click here to read instructions on completing Form 709.
3. Income Tax – Current Tax Year
A gift does not trigger any income tax either for the giver or the recipient. The reason is no income is triggered.
4. Future Income Tax – Future capital gain considerations
One needs to be aware of the effect of a gift on future capital gain taxes.
When a property is sold, there is usually capital gain which is the net sale price (after deducting various expenses) minus the cost basis of the property. If the owner has lived there as his or her main home for at least 2 years in the 5 years prior to the sale, and if the owner has owned it for at least 2 years in the 5 years prior to the sale, then there is $250,000 in capital gain exclusion.
If the owner gifts the property to his son, and assuming the asset has appreciated in value, the original cost basis is also given to the son. When the son sells the property in the future capital gain is computed based on the original cost basis. It may result in a lot of capital gain tax for the son, versus if the property is inherited upon the death of the owner.
Let’s consider this example. The parents bought the house many years ago and the cost was $100,000. Market value is now $500,000. The parents quit claim and gifts the house to the son. The parents continue to live there but the son has his own house. Since the original cost basis is passed to the son, when he sells the house later on, he faces a hefty capital gain tax since the cost basis is only $100,000. He does not get any capital gain exclusion because he has not lived there as his main home for at least 2 years in the 5 years prior to the sale.
Now let’s say the parents keep the ownership, and simply designate the son as beneficiary in their will or living trust. When they pass on, the son inherits the property and the cost basis is stepped up to the full market value on the date of death. When the son sells the property, there is little or no capital gain.
For this reason (and a few others), most parents should not easily gift their residence to their children while they are still alive.
5. Property Tax (California residents)
In California parent-child transfer of properties is exempted from reassessment so there will be no change in the property tax. Any transfer between parents and child, either in the form of a gift, sale or inheritance, would be exempted from reassessment. When the deed is recorded a Form BOE-58-AH should be submitted to claim this exemption. This form is available at the County Recorder’s Office or the Assessor’s Office, or on line at the County Assessor’s websites.