Selling Your Home to Your Kids for a Dollar
Can you sell your home to your kids for a dollar? The short answer is yes. If you own your house, you can sell it to anyone at any price. But, if you sell a $200,000 house to a child for $1, you are really making a $199,999 gift at the time of the sale. The IRS knows that you would not sell the house to a stranger for a dollar. The IRS also knows that the price is only $1 because the buyer is your child. Therefore, it is considered part sale and part gift.
Most folks who ask this question think that such a sale will help avoid estate and inheritance taxes. However, the estate and inheritance taxes on the property depend on whether or not the seller/donor continues to use and occupy the property.
Situation: Seller Does Not Use the Property Post Sale
Let’s take the easy case first. The original owner sells their $200,000 home for $1 and no longer uses or occupies the property. The remaining amount of $199,999 does not escape federal transfer taxes because the IRS treats the $199,999 as a gift.
The $15,000 gift tax annual exclusion is available and a gift in excess of $15,000 starts to use up the giver’s $11.4 million federal exemption equivalent. The exemption is so high that most people don’t have to worry about this. For state inheritance and estate tax purposes, the result will depend on whether the state follows the federal estate tax, or has its own rules.
When a property is transferred by gift, the recipient takes over the donor’s income tax cost or basis. Using our example above, if the recipient sells the house for $200,000 and the cost of the house was $50,000, then the recipient has to report and pay tax on a $150,0000 capital gain. Not the best outcome.
If the donor had held onto the property and it was included in his or her estate, there would have been a step-up in an income tax basis to the date-of-death value, and if the property is sold for the date-of-death value, there is no capital gain to be taxed.
Situation: Seller Continues to Use Property Post Sale
Now for the harder case. We receive a different result if the original owner of the house continues to use and occupy the house after having made the sale for $1 and $199,999. For federal estate tax, the continued occupancy of the residence causes the whole value of the property to be included in the gross estate and subject to tax. The tax authorities take the position that the continued occupancy of the property was part of the deal.
In other words, there was an understanding between both parties that went something like this: I will sell you my house for $1, but you will let me stay in it as long as I want. Even if this understanding is not in writing, the tax authorities have successfully maintained that the agreement existed because, in fact, that is what happened. That’s not a terrible result because remember, there is a $11.4 million exemption from the federal estate tax.
Some folks think that paying rent is the answer. That won’t help either. The general rule is that when any property is transferred during life, and the person who transferred the property retains the income from the property or the use and occupancy of the property, then the full value of the transferred property is included in the transferor’s estate.
There is an exception. If the transfer of the property was for full value, that is, the transfer was a sale and the transferor received other property or cash equal to the fair market value of the property. Paying rent is not full value for the transfer. It may be fair value for the use and occupancy, but that doesn’t help the estate tax question. There are some estate planning techniques that involved changing the title to personal residences. Make sure you receive sound advice from an expert before attempting any do-it-yourself estate planning.