TAXES - how many Taxes can you pay on one transaction? - A Case Study from Real Life.
“I want to give my grandson my home. Can you do a deed for me?” That was the question I was asked one morning not long ago. Seemed like an easy thing to do. I have done thousands of deeds. I have helped prepare and transfer more properties than my share, both to clear title and to transfer title to another, sometimes to a grandchild. So why not do it again?
So, did I do it? NO! Why not? Was it not a chance to help another, perhaps help a grandson to reap the blessing of property ownership, or even help a grandma enjoy the blessings of seeing her loved one bask in her generosity and benevolence? We did not do it because it was the wrong thing to do – unless we want to give a donation to several types of taxes. Let me explain.
We do many things in our life because of Tax consequences. We sell properties because of taxes. We don’t sell properties because of Taxes. We make less money because of Taxes. We make more because of Taxes. We die or don’t die because of Taxes. This was another time we had to consider Tax consequences before we did anything.
So, let’s see how this would go. The Goal was for Grandma to give a property, which she owned free and clear, to her grandson who wanted to live there and use it for a personally owned asset, thus, giving his estate greater net value, with the goal to be able to obtain real estate loans in the future more readily.
Here are some of the tax issues, and solutions to this type of situation that should be considered before going forward with this plan:
First: Will this type of transfer increase someone’s chances of getting a loan? I have found from personal experience that having a property, even if it is free and clear, does not seem help you with getting a loan, or at least has little affect on such. So that idea was not a good reason to transfer the property.
Second: If grandma gives grandson a house, what tax consequences could there be? For one, there could be a gift tax, which results from giving something to another person, with the gift value being worth more than the $14,000 annual exemption currently available through the tax system. With the gift tax currently at 40% on any gift to a single individual over the yearly exemption amount, there is a possibility of having to pay the gift tax. For example, if the house is worth $314,000, you could deduct the annual $14,000 exemption gift, leaving $300,000 value over the annual exemption, which would be taxed at 40%. The easy way to get around this issue is to have the gift giver file a gift tax exemption and have this gift applied toward the onetime $5,490,000 exemption, thus, eliminating the need to pay any gift tax at all. We could turn this into a mere reporting formality. So, you would deduct the $300,000 extra gift from the $5,490,000 One Time Exemption, leaving $5,190,000 to use at a different time. Problem solved.
Third: If grandma gives the property to grandson now, would there be capital gains tax that would have to be paid? When grandma gives this gift to her grandson, he will receive the gift at grandma’s current “Basis” value. This means if grandma purchased the house at $100,000, then her basis value for capital gains calculations would be $100,000. Then, if the property value increases to, let’s say, $300,000, the home would then have a $200,000 of capital gain. (This is calculated by taking the current value, $300,000, minus the original basis amount, $100,000). If grandma were to sell the house today, she would have to pay tax on the “Capital Gains” amount of $200,000. With an estimated 20% Federal and 8% State tax, when grandson decides to sell the property, there would be approximately $46,000 in taxes ($23,000 for each $100,000 of Capital Gain). One method of keeping grandma’s property from having this tax is by having her, instead of transferring the property to her grandson now, allowing her grandson to inherit the property after she has passed away. In that case, there would be a Step Up in basis (an elimination of all capital gains tax) on the property and grandson would have saved the $46,000 in taxes.
Fourth: If grandma gives grandson the property, would the property taxes remain the same or go up? Under California Proposition 13 Property tax rules, theoretically, the property taxes on a property do not go up (substantially) unless it is transferred to a new owner. Which means if grandma sells the property to her neighbor, the property taxes will go up to approximately 1% of the current value. However, under Proposition 13, if you transfer the property to a trust, or to a spouse, or take advantage of several other exemptions, the property taxes will remain the same. Several years later, Proposition 58 created another exemption that you could transfer a property to a child or a parent and the property taxes would remain the same. Unfortunately, this exemption to retain property taxes at current levels upon transfer to a child or a parent Does NOT Apply to a transfer to a Sibling or to a Grandchild, if the Grandchild’s parents are still alive. So, the thing to do first would be to find out if grandson’s parents were still alive to see if property taxes would go up after the transfer. In this case, grandson’s parents were still alive, therefore, if grandma were to give the house to grandson as desired, the property taxes on this property would have gone up (in this case, they would have gone up over $2,000 per year). It is easy to see that it would be a bad Idea to give the gift in this situation.
So, in the end, after taking these possible issues into account, what did we do? We made up a plan of how to get the property to the grandson without having to worry about all of these extra Taxes. To do this we ended up not giving the gift to the grandson directly, but instead, we changed grandma’s trust to give the house to her daughter, after Grandma’s demise, who would then transfer the property to her son (the grandson), thereby keeping the Property Taxes low and at current rates. By allowing him to inherit the property after grandma has passed on, there will be no Capital Gains tax on the growth in value of the property up to the date of grandma’s death. We then allowed Grandson to live in the house, just paying expenses, as he would have done otherwise. This would allow him to show the lending company that he does not have the expense of rent or a mortgage, possibly making it easier for him to get loans for his other property purchases. There would be no Gift Tax, since inheritances are not taxable. There is no Capital Gains Tax, since we will receive a Raise in Basis on the property. There is no Income Tax on the inheritance, the Property Taxes will remain the same, and the house still goes to Grandson, as Grandma wanted. All of the objectives were accomplished, and no extra taxes had to be paid. Everybody wins, (except for the Taxing Authorities!) and everyone gets to keep more of what is theirs.
Following proper rules as we go forward with our plans can Save Taxes, Protect Asset from Creditors and Insure that you KEEP WHAT IS YOURS, rather than giving it away. If you have a question on how to accomplish your desires and reduce your Taxes, give us a call at Beyer, Pongratz & Rosen, a Professional Law Corporation for a Free consultation. Subscribe and make sure you continue getting receiving ideas on how to Achieve your goals in the most tax efficient and protected ways.