10 Mar Tax bill on gifted or inherited home
Q. Hoping you can decide an argument I’m having with my brother. He says we should put our mom’s house in our names to save on taxes. I’m thinking it’s best to receive as an inheritance. Who is right?
— Older brother
A. This might seem like a simple question, but the answer involves income taxes, estate taxes and gifting. The choice your mom makes will impact all these areas of financial planning.
Let’s start with income taxes.
If the house is transferred from your mother to the two of you, then the cost basis of the home also transfers, said Eric Furey, a certified financial planner with RegentAtlantic in Morristown.
The cost basis is the amount originally paid for the home plus any improvements.
Furey offered this example: Let’s say the home is worth $500,000, your mother paid $250,000, and she put in $100,000 of improvements. The cost basis is $350,000. If the home is transferred to the two of you then you also receive the cost basis, which means when it’s time to sell the house you’ll need to recognize a $150,000 capital gain, Furey said. But if the home stays in your mother’s name until she passes away, you’ll receive a step-up in cost basis at the date of death. Instead of your cost basis being $350,000, it will now be the fair market value at the time of her passing, or $500,000. Note that the capital gain taxes will be assessed at the federal and state level, he said.
For purposes of this question, we’re going to assume your mother is a New Jersey resident. That being the case, $675,000 of her assets are exempt from New Jersey estate taxes, Furey said. Anything above this amount will be subject to estate taxes at a sliding scale, meaning the more assets there are ,the higher the estate tax rate will be.
“If the home stays in her name then it will be includable in her estate,” Furey said. “If she transfers the home to either or both of you, then it will be excluded from her New Jersey estate.”
There are some gifting issues that surround transferring the property.
“If she gifts the house to the two of you then she will need to file a federal gift tax return,” Furey said. “This simply tells the IRS that a gift was made above the annual exclusion amount — $14,000 per person.”
New Jersey does not have a gift tax so nothing needs to be filed for New Jersey purposes.
Additionally, Furey said, if she lives in the house after making the gift then she’ll technically owe the two of you rent, and not paying fair market value rent on the property would be deemed a gift.
The best solution is finding the balance between paying estate taxes or income taxes.
“If the home stays in your mother’s name and it’s likely she’ll pass away with more than $675,000 of assets, then you’ll pay estate taxes on her estate,” Furey said. “If the home is transferred to the two of you, then eventually you’ll need to pay capital gains taxes on the appreciation.”
And if it’s likely your mother will pass away with less than $675,000, then the best solution is to receive the home as an inheritance and get the step-up in cost basis, he said.
Before you take any action consult with your tax preparer and consider an estate planning attorney.
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This story was first posted in March 2016.NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.