Written by Francie Peters, an experienced investment management professional.
We asked her to explain gifted real estate with her expert knowledge. She provided a valuable article about the tax consequences and best ways of gifting property, we hope you find it beneficial.
Inherited or Gifted Real Estate in Florida – Five Things You Should Know
Are you trying to decide what to do with inherited or gifted real estate? The financial and emotional decisions on what to do with the property can be overwhelming. It is important to understand some of the jargon used in these types of situations. For example, what does “cost basis” mean? What is a “step-up?” Will the $500,000 capital gains exemption for married couples apply to inherited real estate?
Most parents do not discuss these types of financial matters with their children. Knowing what some of these terms mean could make things less confusing during what is often a stressful time for children when they are trying to decide what to do with an inherited or gifted property.
What is Cost Basis?
In real estate, cost basis is the original value that a buyer pays for their property. This is important because homeowners who sell a property must pay capital gains tax on any money generated above and beyond what they originally paid. For real estate, cost basis will also include the cost of any major improvements made to the property. Certain fees and other expenses may be included in the cost basis. These may include real estate taxes owed by the seller, settlement fees and other costs such as title insurance.
What is a Step-Up in Basis?
If property is received as an inheritance or gift, cost cannot be used as the starting basis. The basis of the inherited property is usually the property’s fair market value at the time the owner passed away. The step-up in basis adjusts the value of an asset when it passes from an owner to their heir. This is a huge benefit as it helps minimize taxes.
Example: Susan inherits her deceased mother’s home. Even though her mother purchased the property thirty years ago for $150,000, the fair market value for the property is $500,000. If Susan sells the property today for $510,000, her total taxable on the sale is only $10,000, representing her profit minus the home’s tax basis. If Susan were to sell the home for less than $500,000, she would take a loss. Note: The loss will not be tax-deductibles as tax code does not allow a loss resulting from the sale of a personal residence.2 Typically, losses are only deducted on the sale of property used for business or investment purposes.
It is noteworthy that the step-up can reflect more than simple property appreciation. Many factors can contribute to it over time. Home improvements, home additions, rebuilding costs following a disaster (this is important in hurricane-prone Florida), and legal fees related to property ownership can be included.
Basis can also be adjusted downwards. Instances where this may occur include casualty insurance payouts, allowable depreciation that comes from renting out part of the home or using it as a place of business, or any other item that amount to a return of cost to the property owner.
There has been discussion in Congress about making changes to the step-up rules. However, no modifications to the step-up rules were included the recently passed Build Back Better Act so the current guidelines remain.
Can a Parent Gift a House to a Child?
If a person gives anyone other than their spouse property valued at more than $15,000 ($30,000 per couple) in any one year, they need to file a gift tax form. Tax law allows gifting of assets of up to $11.7 million (in 2021) over a person’s lifetime without incurring a gift tax. If the house is worth less than $11.7 million and it was given to the children, the parent would not have to pay taxes on it.
Gifting a home, however, can result in capital gains taxes for the children because the children are not allowed to take advantage of the step-up in basis that they could if the property were inherited. Capital gains taxes could be enormous should they decide to sell it because the tax basis (or the parent’s tax basis original cost of $150,000 in the example for Susan above) becomes the tax basis for the recipient.3
Another issue of which to be aware is that gifting a home to a child could have consequences if a parent will be applying for Medicaid within five years of making the gift. Medicaid law looks at assets transferred within five years of applying for Medicaid depending on the value of the assets transferred. If significant assets were transferred during this “look-back” period, the parent may not qualify for Medicaid.
What is the Capital Gains Exemption?
The capital gains exemption benefits sellers when they sell their property. Up to $250,000 of any gain from a sale received by a single homeowner is tax free. For married homeowners filing jointly, up to $500,000 of gain is excluded from income.
An individual who inherits a home won’t qualify for this exemption. To qualify, they would have to move into the home and make it their primary residence for two years.5 Keep in mind, however, the exclusion may not be needed because of the stepped-up basis rules referenced above.
Should the Home be put in a Trust?
Possibly. If the home is put in an irrevocable trust that names the children as beneficiaries, it will no longer be part of the estate (the estate will not pay any estate taxes on the transfer). It is also not subject to Medicaid rules mentioned above.
If the home is put in the irrevocable trust, however, it cannot be taken out again. If the home is sold, the proceeds remain in the trust. And, like making a gift, if applying for Medicaid within five years of transferring the house to the trust, the Medicaid “look-back” period will apply.
Conclusion
Figuring out the best way to pass real estate to your heirs depends on your financial circumstances. Please do not hesitate to call us with questions about the best way to preserve your wealth or the wealth of your children when it comes to passing real estate on to them.
Citations:
- https://www.nolo.com/legal-encyclopedia/determining-your-homes-tax-basis.html. 11/8/2021
- https://www.nolo.com/legal-encyclopedia/deducting-loss-the-sale-home.html#:~:text=If%20you%20sell%20your%20home,for%20business%20or%20investment%20purposes. 11/08/21
- https://www.elderlawanswers.com/how-to-pass-your-home-to-your-children-tax-free-15866
- https://www.medicaidplanningassistance.org/medicaid-eligibility-florida/
- https://www.nolo.com/legal-encyclopedia/avoid-capital-gains-tax-selling-home-29901.html
Founded in 2002, Ullmann Wealth Partners is a Jacksonville Beach-based wealth management firm with a history of helping clients achieve financial independence through their customized, goals-based approach to wealth management. For more information, visit ullmannwealthpartners.com.
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My father has 10 acres with a house that he is trying to gift me, but we are unsure of the process.