Gifts of your real estate can be a bad idea for taxes. What?????? Many of you have probably heard that you should give real estate to your kids to help minimize estate taxes….yes that is still true….but that is only applicable if you have a large estate that will be subject to estate tax. For most people estate tax is not a real concern. Thanks to Congress and its ability to get only politics done….we don’t know who is subject to estate tax at the moment. We’ll know that answer at least by the end of 2010 but for now let’s just assume that if you have less than $1,000,000 then you have no estate tax concerns.
So if you have no estate tax concerns, a gift of your real estate is not saving your family estate taxes; you are wasting your time and money. Of course your kids may not feel that way…who doesn’t enjoy ownership in a beach house or mountain cottage. However they may be interested to learn that the gifts can be bad for their income taxes if they ever plan to sell the property.
If you make a gift of your real estate during life instead of passing the property at death, your kids will use the same cost basis you have in the property to determine their income tax if they ever sell the property. Basically your kids step into your shoes with regard to the built in capital gain in the property. Admittedly, with the recent real estate turmoil, appreciated property ain’t what it used to be, but there are still plenty of old family farms out there that have vast appreciation built in which has not yet been taxed. If that property is passed at death, the cost basis is increased to the fair market value of the property and the capital gain is wiped out, at least to the extent the gain is below $1,300,000. On the other hand, if you transfer the property through gift during life, you loose the benefit of this basis adjustment and your kids will have higher income taxes if they ever sell the property. This rule is true for all kinds of property (stock, art, etc), but real estate is the most common application.
As with any area of tax law there are some exceptions and special facts which may dictate a different plan of action. For example, if the real estate is a principal residence occupied by the child, or if the property is expected to appreciate substantially, or if the family is exploring planning to help with medicaid qualification, then these factors may justify a gift even in the face of the potential income tax detriments. Also, the basis adjustment rules are in flux at the moment and are likely to change further as part of the resolution of the estate tax, whenever that happens.
If you are considering a gift of real estate, make sure you consult your tax advisor first to determine whether you are gaining or loosing any tax benefits.