I get this question about once a month: Mom is moving to assisted living, her house is being sold and the attorney said we should see our tax adviser. If Mom owned and occupied the home as her principal residence for at least two of the five years preceding the sale, the first $250,000 of gain on the sale is tax-free in her 1040. But those rules are so basic that we don't get that question. Rather, it will be one of these situations:
Mom's house was sold, but she didn't own it. She resided there, of course. But 10 years ago, when that son-in-law got everyone excited about nursing home costs, Mom was induced into giving title to the residence to her three kids. Because Mom is not the owner, the $250,000 gain exclusion isn't available. In a gift, the tax basis to the children is Mom's historical tax cost plus improvements. Resurrecting this kind of history is problematical, but that aside, there's generally a significant capital gain tax to the children. And that gain is often hitting 60-year-old children in their peak earning and tax bracket years!
In this variation, Mom didn't convey full title to her children, but instead retained a life estate. This means Mom has a lifetime right to possession and use of the property, but at death title vests in the three children. If property under this title arrangement is sold during Mom's lifetime, the sale proceeds must be allocated. A portion goes to Mom and will be tax-free, but if she is advanced in age, it will be a relatively small portion (IRS life expectancy tables and the monthly IRS interest rate are used to make this determination). The balance of the sale proceeds belongs to the kids, and their share is taxable. The issue of a low, historical tax basis is the same as in the case of a complete gift, meaning the taxable gain may be large.
If Mom passes away with full title to the house and recent occupancy, there generally will be no taxable gain on the sale. Because of the inclusion of the house in Mom's estate, the tax basis is stepped up to its value on the date of death. Similarly, under the life estate arrangement, as well as a full gift of the title with continuing rent-free occupancy by Mom, the property is pulled back into her estate, stepped up in basis, and again no gain occurs. But a costly federal or state estate tax may apply if Mom's total assets exceed the exemption.
I can't opine on the legalities of attempts to keep the value of Mom's house away from the costs of nursing home care. But in four decades of tax experience, I've seen countless situations where the house was sold long before Mom faced those costs and the family was surprised by the capital gain taxes. Before entering into these transactions, consider the income, gift and estate tax consequences of all outcomes.
Editor's note: Andy Biebl is a CPA and tax principal with the firm of CliftonLarsonAllen LLP in Minneapolis with more than 40 years' experience in ag taxation, including 30 years as a trainer for the American Institute of CPAs and other technical seminars. He writes a monthly column for our sister magazine, The Progressive Farmer. To pose questions for future tax columns, e-mail AskAndy@dtn.com.
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