When gifting real estate to beneficiaries, owners should understand the potential for post-gift legal disputes, the property tax implications, and the income tax consequences of the change in ownership. If the property is gifted during the owner’s lifetime, the owner must consider the major legal issues that come with such a transfer.
In this blog, we will walk you through these four concerns.
GIFTING REAL ESTATE TO MULTIPLE BENEFICIARIES COULD CREATE A FAMILY DISPUTE
It’s very common for parents to leave their main residence to their children upon death. However, gifting a single real property to multiple people may lead to a family dispute: each individual child who ends up with an ownership share has the legal right to force a sale of the property via partition action. A partition action requires court action and can impose substantial legal costs on the beneficiaries and the estate.
As an alternative, consider creating a living trust that instructs the trustee to sell the property and divide the proceeds equally among the children. If the parent intends to provide a home for a child, a frequent solution is to have the parent’s trust hold the home as a residence for the child’s lifetime. In the case of disabled beneficiaries who receive public benefits, special caution should be used to ensure they continue qualifying for such benefits; a special needs trust may be needed.
If the intention is to provide financial benefit to the children or other beneficiaries, the owner should not make a specific gift of the property in their trust. Instead, the owner should allow the trustee to sell the property and distribute the cash proceeds among the children.
TRANSFERRING REAL ESTATE TO A CHILD? PROPERTY TAX WILL LIKELY INCREASE
Even if real estate is specifically transferred to your child, a reassessment of the property is likely. In April 2021, Proposition 19 took effect, and it changed the real estate reassessment rules for parent-child transfers.
The most important takeaway for parent-child transfers is that in order for a transfer to be excluded from property tax reassessment, the person making the transfer must have been using the property as their principal residence AND the person receiving the property must use it as their principal residence. A person can only have one principal residence at a time. Additionally, Proposition 19 introduces a base year value adjustment that reduces the available exclusion amount (under Proposition 13, that amount used to be unlimited).
Due to these changes, consider the property tax consequences of specifically gifting real estate to a beneficiary. Depending on the beneficiary ’ s situation (finances, residence, career, etc.), while the parent may intend for the beneficiary to keep the property for the rest of their life, the beneficiary may prefer to promptly sell it to avoid the increased property taxes.
CAPITAL GAINS TAXES CAN RESULT IN DIFFERING BENEFITS TO A BENEFICIARY
Usually, property passing at death receives a new income tax basis. Real property values have appreciated considerably in the past few decades. This appreciation will likely continue, which leaves current owners facing large capital gains, even with the primary residence capital gain exclusion. The “ step-up” in cost basis occurs at death, and it usually removes most of the capital gains tax liability upon a sale by the new owner shortly after the prior owner’s death.
In contrast, transfers of property made in life do not get the same sort of “ step-up” treatment. This means that a gift during life has potentially major adverse tax consequences than a gift a death. Owners should carefully review the cost basis of their real estate and determine the best course of action in terms of gifting, in life versus in death. For people who purchased their real estate decades ago, a transfer at death may be more appealing, as there will be a greater step-up in basis and eliminate of most (if not all) capital gain tax liability.
OUTRIGHT GIFTS OF REAL ESTATE GIVE BROAD POWERS TO THE RECIPIENT
Often, a senior parent will want to “put” a child “on title” to their property to set up that child to inherit the property. A transfer of title is usually an ownership transfer that immediately gives the recipient all the rights of an owner. This creates the potential for elder abuse, since the senior has lost their exclusive ownership rights to the residence. As a co-owner, the recipient child may have an absolute right to occupy the property, so if a dispute arises between the parent and the child, the parent cannot remove the child from the home. Furthermore, the parent may share responsibility for any property-related liabilities incurred by the child.
Therefore, in comparison to an outright gift, a living trust is a far safer method of sharing property with a child. A lifetime residency provision can place rules on the child’s conduct in the residence, and it does not automatically give the child absolute property rights to be misused. Also, if the lifetime gift is made effective only at the surviving parent’s death, the step-up in capital gains tax basis can be preserved.
CONCLUSION
Speaking with an attorney to discuss the best action for your unique situation can make all the difference. This helps ensure that your estate plan will be tailored to fit your specific needs and desired outcomes.
Our attorneys have extensive experience in estate planning, real estate, and taxes. They are happy to assist you with your real estate gifting needs.
