Parents hoping to avoid inheritance tax should think before gifting the family home to a child before they die
October 25, 2013 1:12 AM
By Tim Grant / Pittsburgh Post-Gazette
The season for giving is just around the corner, but parents might want to think twice before gifting their home to their offspring now, rather than letting the younger generation wait to inherit the property in the will.
"I don't like when parents give away their money to the point it jeopardizes their own safety net and comfort in their own retirement," said James Lange, a certified public accountant, attorney and owner of Lange Financial Group in Squirrel Hill. "I often have to talk my clients into hanging on to their own assets."
Bill Richardson, a partner at Sisterson & Co., certified public accountants, Downtown, said many parents get the idea they can save on Pennsylvania inheritance taxes by giving away their house while they are alive.
"Let's say someone had a home worth $200,000 and they wanted to give that home away before they die," Mr. Richardson said. "They will save 4.5 percent, or $9,000, on Pennsylvania inheritance taxes if they get the house out of their estate by giving it to a child.
"You might think on the surface that's a good thing, but it can backfire from an income tax perspective. You very well may save inheritance tax. But the income tax that it could cost your children when they sell could far outweigh the inheritance tax savings."
Mr. Richardson said if the parents in this example bought the house years ago for $100,000 and gave the house away during their lifetime, the child's cost basis also is $100,000 -- the same as the parents'. If the child sells the house for $200,000, the capital gains tax will be calculated based on $100,000 of appreciation.
"If you assume a combined rate of 18 percent [which is a 15 percent federal tax rate and a 3.07 percent Pennsylvania tax rate] on a gain of $100,000, that is $18,000 in taxes," Mr. Richardson said. "That's more than double the savings on your inheritance tax by trying to get that asset out of your estate before you die.
"You would be better off paying the inheritance tax, letting your child inherit the asset and, when it is sold, the income tax savings would far exceed the inheritance tax cost."
Not every situation is the same. The parents could have paid $200,000 for a house that is still worth $200,000. There would be no income tax if the parent or child were to sell it.
Yet other things could go wrong, Mr. Lange said.
What if the child who is a beneficiary of the gift goes through a divorce? What if the child who receives the house dies before the parents?
"The main reason parents don't want to give away their house before they die is they might need it," Mr. Lange said. "They may need the equity.
"Let's assume they end up in a retirement home. If they don't like it there, as long as they have the money, they can move to another facility. As long as you have the money, someone else will take you."
Tim Grant: email@example.com or 412-263-1591.
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