Thinking About Transferring Your Home – Have You Considered the Tax Implications? – Part 1

Fredrick P. Niemann, Esq., a NJ Real Estate Attorney

“Mom wants to transfer her home to me.  Do you think it’s a good idea?”  A seemingly simple question and one that is probably one of the more common questions I am asked as an elder law attorney.  But, not one that I can answer without knowing more.  One size does not fit all.

The home is typically the largest asset people have and they are frequently and understandably emotionally attached to it.  The primary residence also enjoys special tax treatment and that is what most people fail to consider when they make the decision.  Let’s run through the basics.

Real estate, like stocks, bonds and other investments, is subject to capital gains tax.  If Mom bought her home for $100,000 and sells it for $500,000 she has what is called a “realized gain” and Uncle Sam will want to tax her on that gain.  The gain is calculated by taking the amount she sold the home for and subtracting the “cost basis”.  The cost basis is her purchase price plus capital improvements (eg. addition, new roof, windows, siding) and closing costs.

In my example, if Mom made no improvements her gain is $400,000.  The capital gains tax she must pay is based on her tax bracket. The higher the bracket the higher the tax, although capital gains tax rates are lower than for regular income.  Let’s say her tax rate is 20% so her potential capital gains tax is $80,000.  I say “potential” because, if the home was her primary residence in 2 of the 5 years before she sold it then she can exclude up to $250,000 of gain.  Married couples can exclude $500,000 of gain.

If Mom transfers her home to me and I don’t make it my primary residence then when I sell I won’t be able to exclude any capital gains from tax.  But, Mom still intends to live in the home.  Should she retain a life estate?  What if I don’t want to sell it until after she passes away?  Is there a way to avoid the capital gains tax, entirely? 

Yes, by invoking something called the “step up in basis”.  If Mom owns the home when she dies and passes it to me upon her death my cost basis when I sell is not what she paid for it, but rather what it was worth at the time of her death (or, alternatively, 6 months after her death).  If I sell it immediately after she dies my capital gains may be zero or a loss, and thus, there is no tax on a refund.  If I sell after Mom dies, but she transferred it to me during her lifetime, then I will likely owe Uncle Sam capital gains tax. 

So, then that’s it, right?  Mom shouldn’t transfer the home to me.  Well, not so fast.  What if Mom gets sick and needs long term care?  We’ll tackle that one in next week’s post.

For further information and advice in any real estate matter, do not hesitate to contact me at 732-863-9900 Ext. 101 or 105, or fniemann@hnlawfirm.com/.

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