With the increase of the federal estate tax exemption to $5,340,000 in 2014, most taxpayers are not subject to federal estate taxes. The focus for many now has shifted to the income tax implications that arise when wealth passes to the next generation. With no regard to the income tax implications, many times elderly people get the idea that the transfer of real estate to children during their lifetime is a good idea in trying to avoid probate and to make things easier for loved ones. Even uninformed realtors, attorneys and other financial advisers sometime make such a recommendation without knowing the tax impact. However well-meaning, this uninformed strategy can have disastrous income tax results for the children recipients of such ill-conceived lifetime gifts.
It is important to understand the following income tax basis rules for calculating gain or loss:
Example: DIY Dad wants to avoid probate and to transfer during his lifetime his real estate to his son, Sad Son. DIY Dad bought his house in the 1970s for $17,000 and made improvements during the years of $23,000. As a result his adjusted basis is $40,000. The house is now worth $540,000. To save lawyer fees, DIY Dad asks Sad Son to draft a deed to transfer the property. Sad Son does so and DIY Dad signs the deed and has it recorded with the recorder of deeds.
It is important to understand that in some situations gift giving may make sense. The following examples come to mind and there may be others depending upon the situation:
This discussion does not explore any Medicaid qualification issues and such considerations should be explored with an elder law attorney specializing in this area.
The key point of this discussion is that making transfers just to avoid probate can result in a tax disaster for your family. Do not do it yourself. Each taxpayer’s particular situation is unique and should be looked at by trained professionals to develop a workable, comprehensive and integrated estate and income tax plan. Get a tax or estates attorney along with your CPA and financial adviser to develop a plan that reduces taxes while still accomplishing your overall financial and estate goals for your family.
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