Giving your house to your children can have tax consequences, but there are ways to accomplish it tax-free. The best method to use will depend on your individual circumstances and needs.

Leave the house in your will

The simplest way to give your house to your children is to leave it to them in your will. As long as the total amount of your estate is under $5.45 million (in 2016), your estate will not pay estate taxes. In addition, when your children inherit property, it reduces the amount of capital gains taxes they will have to pay when they sell the property later.

Capital gains taxes are taxes paid on the difference between the “basis” in property and its selling price. If children inherit property, the property’s tax basis is “stepped up,” which means the basis would be the value of the property at the time of death, not the original cost of the property.

However, there are 2 major downsides to leaving the house in a will without a trust: probate and Medi-Cal recovery claims.  Without a trust, your children have to go through an expensive and lengthy probate court proceeding to inherit the house. Further, Medi-Cal is entitled to a recovery claim and your children may have to sell the house to pay the Medi-Cal recovery claim.

Leave the house in your living trust

The simplest way to give your house to your children is to leave it to them in your living trust. As long as the total amount of your estate is under $5.45 million (in 2016), your estate will not pay estate taxes. In addition, when your children inherit property, it reduces the amount of capital gains taxes they will have to pay when they sell the property later.

Capital gains taxes are taxes paid on the difference between the “basis” in property and its selling price. If children inherit property, the property’s tax basis is “stepped up,” which means the basis would be the value of the property at the time of death, not the original cost of the property.

Plus, by leaving the house in a living trust, you avoid probate.

In addition, California recently changed the Medi-Cal estate recovery laws. Starting on January 1, 2017, property that avoids probate is not subject to recovery by Medi-Cal. So if you leave the house in your living trust, the house will not be subject to the Medi-Cal estate recovery claim because it will avoid probate.

Gift the house

When you give anyone other than your spouse property valued at more than $14,000 ($28,000 per couple) in any one year, you have to file a gift tax form.  But you can gift a total of $5.45 million (in 2016) over your lifetime without incurring a gift tax. If your residence is worth less than $5.45 million and you give it to your children, you probably won’t have to pay any gift taxes, but you will still have to file a gift tax form.

The downside of gifting property is that it can have capital gains tax consequences for your children. If your children are planning to sell the home, they will likely face steep capital gains taxes. When property is gifted, it does not receive a step up in basis, as it does when it is inherited.

When you give away your property, the tax basis (or the original cost) of the property for the giver becomes the tax basis for the recipient.

In addition, gifting a house to your children can have consequences if you apply for Medi-Cal within 30 months (or 5 years in states other than California) of the gift. Under California’s Medi-Cal rules, if you transfer assets within 30 months before applying for Medi-Cal, you will be ineligible for Medi-Cal for a period of time (called a transfer penalty), depending on how much the assets were worth.

Sell the house

You can also sell your house to your children. If you sell the house for less than fair market value, the difference in price between the full market value and the sale price will be considered a gift.

As discussed above, you can use the $14,000 annual gift tax exclusion as well as the $5.45 million lifetime gift tax exemption on this gift. The same issues with gifts discussed above will apply to this gift.

Another option is to sell the house at full market value, but hold a note on the property. The note should be in writing and include interest. You can then use the annual $14,000 gift tax exclusion to gift your child $14,000 each year to help make the payments on the note. This can be tricky and you should consult with your attorney to make sure this won’t cause tax problems.

Put the house in an Medi-Cal Protection Trust

Another method of transferring property is to put it into an irrevocable trust such as a Medi-Cal Protection Trust.  Similar to the living trust discussed above, if you put it in an irrevocable trust that names your children as beneficiaries, the house will no longer be a part of your estate when you die, so your estate will not pay any estate taxes on the transfer. The house will also not be subject to Medi-Cal estate recovery.

The downside is that once the house is in the irrevocable trust, it cannot be taken out again. Although it can be sold, the proceeds must remain in the trust.

This is advantageous over a living trust if you have Medi-Cal and may have to sell the house while you are still living.  While a house is an exempt asset under Medi-Cal eligibility rules, proceeds following the sale of the house is not.  If you sell the house while you are still living and the house is not in a Medi-Cal Protection Trust, you may lose your Medi-Cal benefits.

Ask an Attorney for Help

Figuring out the best way to pass property to your children will depend on your individual circumstances. Talk to your elder law attorney to decide what method will work best for your family.

Marsala Law Firm can help advise you on your best options.  Please call (310) 237-3872 now for a free telephone consultation.