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The Wealth & Wisdom Blog

Information on Estate Planning, Estate and Trust Administration and Unique Asset Planning

They made us an offer we could not refuse.” One of our neighbors recently sold their residence after receiving an unsolicited offer.  This neighbor took advantage of the significant increase in residential property values not just in our neighborhood, but across the country. Relatedly, our law firm is corresponding with numerous clients seeking advice on the most efficient means of transferring residential property to children.  In this month’s update, I briefly summarize the tax implications of transferring ownership of residential property to children by sale, gift or following death.

Transfer by Sale

A residential property can be sold to a family member.  In general, capital gains taxes are imposed on the sale of any appreciated asset, including real estate, with the capital gains tax imposed on the difference between the sale price and the “cost basis” in the property.  However, if the residential property is the seller’s primary residence, most or all of the gain in the value of the property would be excluded from capital gains taxes by reason of a specific exclusion to capital gains taxes called the “primary residence sale exclusion.”  To qualify for this valuable exclusion, the seller(s) must have considered the residence to be her primary residence for at least twenty-four months of the sixty months immediately preceding the sale.  If so, married sellers can exclude up to $500,000 in appreciation from capital gains, and a single seller can exclude $250,000 in appreciation from capital gains.  The primary residence sale exclusion applies regardless of whether a homeowner is selling to a disinterested third party or to an interested family member.

Transfer by Gift

A residential property can be gifted to a family member.  No income taxes are owed by the child-recipient although, for capital gains tax planning purposes, the original owner’s cost basis in the residence is “carried over” to the child-recipient. The gift of the residence should be reported on a federal gift tax return, even though no gift taxes are likely due.

If the property is transferred during lifetime to a child, consider the following important legal matters:

  • Appraisal of Residence. If adequate disclosure is made to the IRS of the transaction, the IRS will have only three years to contest the value used.  To start this statute of limitations, we generally recommend that clients obtain a qualified appraisal of the residence.
  • Ownership Attributes. For our clients with estate tax concerns, it is important that the ownership formalities be respected.  Once transferred, the child-recipient should be responsible for all property taxes, utilities, and insurance.
  • Seller-Financed Transactions. Instead of receiving cash from the child in exchange for the residence, some of our clients are in a financial position to provide a loan to the child.  By IRS rules, these intra-family loans must charge minimum interest rates, and the parents must report the interest on such loans as taxable income to the parents even if the parents never actually receive interest payments from the children.  If the child makes payments on the loan, the child is entitled to an income tax deduction for the interest payments due under the loan only if a mortgage is recorded on the residence.
  • Recording Costs. In the state of Minnesota, a state deed tax of 0.33% of the sale price is due whenever a property is transferred on account of a sale.   If a mortgage is recorded with the county, a mortgage registration tax of 0.23% of the mortgage value is due.

Transfer Following Death

Finally, a residential property can be transferred to family members by reason of the death of the owner/resident.  The residence in this event would receive a full cost basis “step-up” at death.  Unlike the primary residence sale exclusion, there is no limitation on the value of the step-up in cost basis at death.