A common question I’m asked is: What’s the best way to give my house to my kids? In most cases, parents want their kids to inherit their property with a minimum of taxes owed. This is particularly true of the family house, which kids may want to keep in the family. However, whether a property is kept or sold, parents want to minimize the taxes. So, what’s the best way to pass property to kids?
To figure it out, let’s first look at what taxes may be owed on a transfer of real property. First, there’s the property tax. This is the tax you pay to California every year on any piece of real property you own. There is a limit to how much California can raise your property tax every year. Still, a transfer of ownership will trigger a reassessment, which could mean a significant increase in the property tax if the house was purchased a long time ago. There is an exception for a transfer from a parent to a child, but this exception only applies if the property is the parents’ residence, and the child moves in and makes it their residence (thank you, Prop 19). On the bright side, this exception can be applied regardless of how the property is transferred.
Second, there’s the capital gains tax. This is the tax that is due when the house is sold. It is calculated by determining the difference in value from the date of purchase to the date of sale, and the seller is charged a percentage of that difference. For example, if you bought the house at $400,000 and sold it for $700,000, you would owe capital gains tax on the $300,000 increase in value.
Here’s the thing about capital gains tax: when a property is inherited, it gets a “step-up in basis.” This means that when the government is making the calculation, they’ll look at the difference in value from the date of death to the date of sale rather than the date the property was originally purchased. This could result in a very big tax break if the property was purchased a long time ago. However, you only get this step up in basis if the property is inherited; you don’t get it for property that is gifted or purchased.
Given the above, I believe the best way to pass property to kids is through inheritance. If you gift it or add them as joint tenants during life, they won’t get the step up in basis and will have to pay significantly higher taxes when it’s time for them to sell.
Of course, every family is different, and there may be circumstances where other transfer methods make more sense. If you would like to discuss your situation with me, you are welcome to email me at kaway@kawaylaw.com.
