My parents have decided to downsize and move into senior housing. I have always loved my parents’ house and my goal was to buy it from them. When I approached my parents about buying their house, they said that I can have it and I don’t have to pay them. I have a couple of questions about this. The first is, what documents do I need to make everything legal? Second, my dad’s tax accountant said that my parents would have to pay gift taxes because they’re giving me the house all at once. The house needs work and updating and it is worth about $150,000. My question: is there a way to avoid the gift taxes that my parents would owe?
From a legal standpoint there are two documents that I think you need. The first is a quit-claim deed. A quit-claim deed is a document that your parents would sign which transfers ownership of the house to you. The quit-claim deed should be witnessed and notarized. The effect of this document is that your parents are transferring whatever ownership they have in the home to you. A quit-claim deed is typically used when families transfer property to each other or to a trust. If you were buying a piece of property from a third party you would want what is known as a warranty deed. A warranty deed contains certain warranties and representations about the ownership of the property.
Once the quit-claim deed has been properly executed, it would then be filed with the county. It is also important that if the house is going to be your primary residence to complete the necessary paperwork regarding the tagging of the property as your homestead so you get more favorable terms when it comes to your property taxes.
The other document that I believe you should have your parents complete is a gift letter. Your parents should put in writing that they are transferring the property to you as a gift. Once again, I would recommend that this document be witnessed and even potentially notarized. This is a document that you don’t need to record anywhere but you should keep with your safe papers in case someone in the future tries to challenge you regarding the transfer of the property.
The tax accountant was correct that there are gift tax consequences to the transfer of the property. However, there is a relatively simple way to avoid your parents having to pay the gift tax. First, it’s important to understand gift taxes. Unlike income taxes where the person receiving the money pays the tax, it’s the exact opposite with a gift tax. In a gift tax situation, the person who gives the gift is the one who is responsible for the tax. The major exception to the gift tax rule is that you can give whomever you want $14,000 a year without any gift tax consequences. Therefore, in the situation at hand both your mom and dad can combine and give you $28,000. If the house is worth $150,000 the first $28,000 is gift-tax free and thus, the remaining $122,000 is subject to gift taxes. However, there’s another exclusion that you can use to reduce the amount subject to tax to zero.
Under our estate and gift tax laws, everyone has an estate and gift tax exemption that is currently valued at over $5 million. What this means is that if someone passed away and had an estate of $5 million, they can totally avoid all estate taxes. However, what few people know is that you’re not limited to use your exclusion at death; you can use it during your lifetime. Therefore, in the case at hand, with the remaining $122,000, your parents can each choose to use $61,000 of their exclusion. Thus, the result between using the two exclusions would be zero tax liability.
In order to use your lifetime exclusion you will have to file a gift-tax return. There won’t be any tax liability but it is important to file the return.
Gifting real estate to a loved one is relatively straightforward and simple. However, it is important that you dot all of the I’s and cross all of the T’s. We all know how family dynamics are and therefore, having an attorney draw up a quit-claim deed and the gifting documents may be appropriate. The charge should be nominal but it can provide you a ton of protection if something does occur in the future.
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