Dear Real Estate Adviser,
My father bought a house many years ago that is fully paid off. He now wants to gift it to me. What are some of the tax consequences and other considerations we should think about?
-- Nancy R.
A and N photography/Shutterstock.com
First of all, gifting a home may be problematic for your pop if he needs Medicaid coverage in the near future. That's because Medicaid has a five-year "look-back" period to determine if applicants have transferred off any major assets to become eligible.
A penalty in the form of a multiple-month delay in coverage could be assessed against him.
If we assume the average monthly cost of nursing home care in your state is $6,000, then Dad would have to wait years for Medicaid to kick in.
For example, if he transferred a $240,000 house to you on May 1, 2017, and unexpectedly needed to move to a nursing home on May 1, 2018 and spent down his remaining assets to become Medicaid-eligible on May 1, 2019, that's when the penalty would begin.
It's duration in this case would be 40 months ($240,000/$6,000 = 40), meaning he wouldn't become eligible for coverage for three years and four months. You will definitely need to talk with a qualified estate or elder law attorney or financial planner if you think he may need Medicaid at some point.
Would he incur a gift tax?
If not, gifting a home makes more sense, assuming he hasn't already given away millions. While a person giving away property valued at more than $14,000 in a given year must file a gift tax form, that gift will only be taxed if it causes him to exceed or further exceed his lifetime federal individual estate and gift-tax exemption limit of $5.49 million (up from $5.45 million last year).
So unless your dad is relatively wealthy and has gifted enough in his life to exceed that threshold, he won't incur a gift tax by giving you the house.
But you should also know that if you were to sell the place quickly after receiving it as a gift, you would face a hefty capital gains tax. That's because when a home is given away, its original cost to the giver -- its "tax basis" -- becomes the recipient's tax basis unless that recipient lives in it for at least two years before selling.
In other words, if your dad bought the house for $140,000, and you turned around and sold it off posthaste for $240,000, you'd owe capital gains taxes on that $100,000 profit, if you sold before those two years expired.
In another tax-saving scenario, your dad could sell the house to you for market value at a low down payment and hold the note himself, possibly with an arrangement to forgive the balance of the note if he dies before you pay it off.
RATE SEARCH: Find the best rate on a mortgage today.
Avoid being targeted by the IRS
Then, there are a couple ways your dad could give you the house and still live there without feeling the wrath of the IRS, assuming you are inclined to live together.
One is with a qualified personal residence trust, or QPRT, which would allow Dad to move the residence out of his taxable estate without vacating it. An IRS formula would then put a value on his right to live in the house with the balance considered a gift, subject to that $5.49 million federal gift tax exemption limit.
The other way is if he was to sell you the home for fair market value but pay market-level rent afterward to remain there.
RATE SEARCH: Check out Bankrate.com for your best mortgage options.
As for simply inheriting the property when he dies, the home's tax basis would then get "stepped up" to market value, which would eliminate capital gains taxes on any appreciation your dad enjoyed on it after he bought it. However, the home would remain in the estate and be subject to any estate tax consequences.
The decision of whether or not to use any of the above options depends on your father's overall financial picture. That's another pressing reason to involve an attorney or financial planner. As you can see, gifting a home can get complicated.
Kudos to your generous dad. Just make sure the gift is structured in a way that you don't unnecessarily burden your father or yourself. Good luck to you both!