8 Things To Consider While Gifting a Home to Your Children

Parents, all over the world are always trying to help their children succeed in life, become the best version of themselves, and achieve their goals as early as possible in life. When it comes to financial goals, one of the most common asset that most people dream about is owning a home. In essence, a dream house is much more than a mere financial asset. It is also a place to bond, grow old together, raise your kids and grandkids, and more. However, as crucial a role a home plays in the life of an individual, finding ways to procure one is not as easy.

Purchasing a home can be a long, exhausting journey, filled with long term planning, investing, saving, and also debt in the form of home loans. Moreover, even after you own a home, you are likely to be burdened with loan repayments, high interest rates, renovation and repair expenses, and a lot more. Having gone through this journey once, many parents want to make things easier for their children. And this can be done by gifting your children a home. However, gifting a home is not as easy and can lead to tax implications for you and your child. Hence, it is important to know of certain rules and regulations that must be followed while gifting an asset, such as a house to your heirs, and strategies that can help smooth things out with minimal tax liabilities.

Here are eight things you should keep in mind while gifting a home to your children:

• Find out your child’s needs before you gift them a home:

It is important to understand the unique needs of your child. Gifting a home may not always be the best thing you can do for your children. For instance, in the case of owning multiple assets, each of your children may desire a distinct asset. There could be a disagreement between your children that can lead to family feuds. Moreover, if you leave your child a home they have no value for, may not result in the same outcome as you hoped for. These situations normally occur when you gift your children a home in one state while they reside in another state or country. In these cases, either the child has to travel back to the state where the house is located and find a tenant to occupy it or sell it to a new owner. The sale can in turn, trigger taxes for your child that may sometimes negate the profit from the sale of the house. The selling price of the house will also depend on the time and location of the sale. For instance, selling a house in the year 2020, when the real estate market was struggling due to the Covid-19 pandemic, would have resulted in a loss. Adding to this, if the location of the house is not in an upcoming or developed area or neighborhood, the chances of a resale or earning a profit are further reduced. These factors make gifting the house an experience full of hassles and paperwork for your child. Hence, it may be better to find out your child’s needs and future requirements before you gift such an expensive asset to them.

• Understand the gift tax that will be levied on the house before you gift your child a home:

Gifting a house to a child can be a great strategy as this removes the responsibility of the loan from your child’s shoulder. They no longer have to save or invest for a home purchase and can concentrate on other essential factors in their life, such as the higher education costs of their own children, saving for retirement, improving their standard of living, and more. However, while gifting a house is an advantage for your kids, it can be a disadvantage for you due to the tax levied on it. The Internal Revenue Service (IRS) charges a gift tax on highly valued assets and the transfer of wealth. The limit for a gift tax in the U.S has been fixed at $15,000 a year for a single person and $30,000 for a couple. This means that you can give gifts amounting up to $15,000 individually or $30,000 as a couple to another person once a year without incurring any tax liability on it. So, for instance, if you gift a family member assets worth $40,000 in a year, you will be liable to pay a gift tax on $40,000 – $15,000 = $25,000. Now, since a house is likely to be valued at a higher price than $15,000, it would therefore lead to a gift tax. However, there is a way around this.

Apart from the gift tax limit, there is another limit that you can make use of while gifting a home to your child. In the U.S., there is also a lifetime limit on gift tax. In 2021, this has been fixed at $11.7 million. This implies that you can give gifts amounting to $11.7 million over the course of your life without having to pay any gift tax. So, if the value of your home is within this limit, you will not have to pay any tax on it. However, you will have to file a gift tax form to show that the house has been gifted to another person.

• Know that your children have to pay capital gains tax when you gift them a home:

Even though the lifetime limit on gift tax can be a good way to reduce your tax liability, gifting a home can still trigger taxes for your children. In order to understand this, you must know the difference between gifting a home to a child and passing it on in your will. When you gift a home to a child, the tax basis of the house is calculated as per the original cost of the house and not its present value. For instance, if the original value of the house was $200K and its current value is $400k, the tax basis will be $200k if you gift it to your child. In this case, if your child decides to sell the house, the capital gains tax will be computed on the basis of its original value and not its present value. This can lead to higher taxes and lower profits for your child.

• Understand that gifting a house can interfere with Medicaid benefits:

If you transfer any asset, such as a house within five years of applying to Medicaid, you would be deemed ineligible to use Medicaid for a certain period. This is known as the transfer penalty. The transfer penalty depends on the value of the asset or gift and is also imposed if the gift’s worth was within the gift tax limit of $15,000 in a year. However, there are certain exceptions to this rule, such as:

• You can transfer a home to a child below the age of 21.
• You can gift a home to a child who is blind or disabled.
• You can gift a home to a child who was your caretaker, thereby referring to a child who lived in the house in question for a period of least two years before you were institutionalized or put in a nursing home.

Hence, if you have recently applied for Medicaid, it would be advisable to wait for five years before you gift your child a home.

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• Consider selling the house to your child at a lower price:

Another way to gift the house to your child is through a sale. This can be a good option if you do not want to gift the house to a child but at the same time, offer them some respite from market rates. However, the difference in the sale price and the market price will still be considered a gift by the IRS. For instance, if the fair market value of the house is $450k and you sell the house to your child at a reduced cost of $350k, the IRS will count the difference of $100k as a gift. But, just like how you can use the lifetime limit of $11.7 million while gifting the house, you can use the lifetime limit to cover the difference in the amount in the case of a sale too.

There is another approach to sell the house to your child. You can sell the house to your child at its fair market value on the understanding that your child will pay you interest installments every year. You can use the $15,000 gift tax limit to cover these installments. In the case of spousal property, this can be $30,000 a year. However, it may be advised to seek legal help to get the written documentation in place.

• Use a Qualified Personal Resident Trust (QPRT) to transfer ownership of a house:

A QRPT is a type of irrevocable trust that can be used to gift a child a house. A QRPT allows you to transfer a house to a future beneficiary of your estate, such as a child. You can continue living in the house up to a certain date as specified in the trust, post which the house is transferred to the child. This can be a great approach if you wish to continue living in your house for a few more years and yet want to reduce the tax liability that will likely accrue if you were to wait that long.

This is how a QRPT helps you: If your house is valued at a price of $450k today and may appreciate to $500k or more five years from now. However, if you make a trust right now and set a maturity date five years in the future, the value of the house will freeze at $450k even five years from now. So, when the house is finally transferred to your child, the gift tax will be levied on $450k and not the increased value of the house. Meanwhile, you can continue living in the house as before. However, keep in mind that most parents take this route towards the end of their life. They pick a maturity date anticipating that they may not be around by then. However, if they outlive the date, the house will be legally owned by the child and not the parents. In this case, the child would be the one to decide who lives in the house.

• Make a transfer-on-death deed to transfer a property:

You can make a transfer-on-death deed for any property. Such a deed states that the asset will be automatically passed on to your child upon your death. In the case of joint property, the deed will only be transferred after both spouses have passed away. However, keep in mind that along with the transfer of the house, the recipient, in this case, your child, will also inherit any loan payments, mortgages, etc. on the house. Moreover, not all states offer this option, so it may be best to check if the state you reside in allows such a deed. The good part however, is that you can change or modify the deed anytime you want and also avoid probate.

• Gift your house to your child in your will:

Perhaps the most common way to gift a house is to leave it in your will. The house, along with any other assets, will be passed on to your child on your death. Any estate taxes will also be levied at that time. But if you plan to use a will to transfer the ownership of a house, make sure to discuss it with your child before. Understand their needs and accordingly make a decision. It can be hard to correct things once you are no longer around.

To sum it up

There are multiple ways to gift a house to your child, but the right method would differ based on your situation, the value of the house, your child’s preferences, the area of residence, and more. It can help to consult a professional financial advisor and get appropriate advice to assist you in making the right decision.