The Tax Implications of Selling Your Home to Your Kids for a Dollar
A gift tax, estate tax, or even capital gains tax could come due
Can you sell your house to your son for a dollar? The short answer is yes. You can sell property to anyone you like at any price if you own it. But do you really want to?
The Internal Revenue Service takes the position that you're making a $199,999 gift if you sell for $1 and the home's fair market value is $200,000, even if you sell to your child. You could owe a federal gift tax on that amount.
Gift Tax vs. Estate Tax
You might think that "selling" your home to your child will help you avoid estate taxes down the road at the time of your death, but the IRS is a step ahead of you. The federal estate tax and the gift tax go hand in hand. The major difference between them is your timing. When are you transferring ownership of assets?
You can pay a gift tax on the transfer now, or your estate can pay an estate tax later, and both taxes share the same federal exemption from taxation at the end of the day. Whether you'll actually have to pay a tax depends on the extent of your assets and how generous you are over the course of your lifetime.
If You Don't Use the Property Post-Sale
Let’s say that you sell your $200,000 home to your son for $1 and you no longer use or occupy the property. The remaining $199,999 doesn't escape federal taxation because the IRS treats the $199,999 uncompensated value as a gift.
The tax code provides for a $15,000 gift tax annual exclusion as of 2020—per person, per year—so that $199,999 gift is now reduced to $184,999. You don't have to pay the tax on the fist $15,000. Now you have a choice to make.
You can pay the gift tax on that amount in the year you make the gift, or you can apply that $184,999 to your lifetime exemption. This exemption is $11.58 million as of 2020. You can give that much away one way or another—during your lifetime or from your estate after your death—without incurring either a gift or an estate tax.
The annual exclusion and the lifetime exemption are both indexed for inflation, so they can increase somewhat from year to year. But the annual exclusion can only increase in $1,000 increments, and this doesn't necessarily happen annually.
Eleven-plus million is a lot of exemption, but here's where it gets tricky. This lifetime exemption covers both the gift tax and the estate tax. So assuming you decide to kick that $184,999 over to your lifetime exemption, now you have only $11,395,001 left of the exemption to shield your estate from taxation when you die.
Most people don't have to worry about this because the exemption is so significant, but this might not be the case at the state level. Twelve states and the District of Columbia impose an estate tax, and some of their exemptions are much less—it's just $1 million in Massachusetts as of 2020. Connecticut and New York have some form of a gift tax and estate tax as well.
What If the Recipient Sells the Property?
Your son inherits your tax basis—basically what you paid for the property—when you transfer it to him as a gift during your lifetime. If he turns around and sells the house for its $200,000 value, but you only paid $50,000 for the property way back when, he must report and pay tax on a $150,0000 capital gain, the sales price less your basis.
But there's a "step up" in basis if you hold onto the property and transfer it to your son as part of your estate. His basis becomes the property's date-of-death value in this case. There's no capital gain and no capital gains tax due if your son sells the house for $200,000 and that's its fair market value.
If You Continue to Use the Property
The picture changes if you continue to use and occupy the house after having made the sale for $1. Your continued occupancy of the residence causes the whole value of the property to be included in your gross estate and subject to estate tax. The IRS takes the position that your continued occupancy of the property was part of the deal.
In other words, there was an understanding between you and your son that went something like this: "I will sell you my house for $1, but you will let me live there as long as I want." Tax authorities have successfully maintained such an agreement exists, even if it's not in writing, because, in fact, that is exactly what happened.
That’s still not necessarily a terrible result, however, because there's that $11.58 million lifetime exemption waiting in the wings to take care of things.
You Rent the Home Instead
Some folks think that paying rent is the answer, but this won’t help, either. The general rule is that when any property is transferred during your lifetime, and if you retain the income from the property or the use and occupancy of the property, the full value of the transferred property is included in your estate.
But there's an exception if the transfer of the property is made for full value—the transfer was a sale and you received other property or cash equal to the fair market value of the property. Unfortunately, paying rent isn't full value for the transfer. It may be fair value for the use and occupancy of the dwelling, but that doesn’t address the estate tax question unless you pay your son $199,999.
Some estate planning techniques involve changing the title to personal residences. Make sure you receive sound advice from an expert before you do so or attempt any do-it-yourself estate planning. The information contained in this article is not intended as tax advice and it is not a substitute for tax advice.
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