Should you gift your rental property to a family member to remove it from your estate? This is a question we sometimes hear, and the answer is that it depends on a few things, particularly the size of your estate and the tax implications for your heirs.
Estate Planning: Inventory Your Assets
The general rule in 2017 for estate taxes is that everyone has a $5.5 million annual gifting exclusion. So, if someone dies and their estate is under $5.5 million, there’s no estate tax. Gifting the rental property depends on whether you’re even subject to estate taxes. If you are subject to estate taxes because your estate is over $5.5 million, you should take an inventory of all the assets in your estate. Decide which make the most sense to gift out so you can be under the $5.5 million. You can be more aggressive with some valuation on certain assets. If someone has $4 million of stocks and bonds and $2 million in real estate, the valuation of stocks and bonds are pretty fixed. You’ll know what they’re worth on the date of death. With real estate, sometimes there is flexibility in terms of the appraisal process. There might be a possibility in valuing the assets differently.
Gifting Rental Property and Taxes
If you are under the $5.5 million, normally it makes sense to wait until the parent passes away. Here’s an example. Maybe a parent buys a rental property for $500,000, and now it’s worth $1 million. They’ve taken some depreciation so the tax cost in that property is only $200,000, but it’s worth $1 million. If they gift that property to their daughter, the daughter’s tax basis is only $200,000. So, when she goes to sell it and it sells for $1 million, she’ll have to pay taxes on the $1 million sales price. But, if the parent passes and that rental property is worth $1 million, the daughter will get a date of death step up in cost, so now her tax cost basis is on the $1 million property value. When she sells the property for $1 million, she has no tax. If your estate is under the $5.5 million, it makes the most sense to transfer the property to the child at death.
We have run into situations where parents are concerned with things outside of taxes. Maybe the parent is trying to qualify for Medicaid because they are having health problems with no long term care insurance. With too many assets, they won’t qualify for benefits. So, in certain situations it may make sense to gift the properties before the parent passes. But, the general rule is to wait.
If you have any questions about gifting rental property to a family member or you need help with San Diego property management, please contact us at Mercer Properties.Craig V. Castanos is a Certified Financial Planner and Certified Public Accountant located in San Diego, CA.