Who Knew This Could Bite You in the Butt?

Ted Jenkin
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The Potential Pitfalls of Real Estate Inheritance

There are plenty of conversations we would just rather not have with our aging parents. No one wants to discuss health issues or financial topics. Legal discussions are fraught with discomfort; who wants to discuss death and dying with anyone much less their closest loved ones?

A qualified personal residence trust (QPRT) is a way for your parents to remain in their house while also starting the gifting process.

However, we also know it is imprudent to ignore reality especially when it comes to dollars and cents.

That being said, let’s consider real estate as one’s primary residence is generally the largest asset  most people hold in their financial lives. Perhaps your parents are considering and have mentioned — the idea of gifting you and your partner their home. Or, maybe they haven’t even thought about it.

Either way, this is a conversation that should happen sooner rather than later for a variety of reasons. Whether the transaction is financially or emotionally motivated, gifting a primary residence is miles away from a straightforward transaction. It can have both intended and unintended consequences.

As the potential recipient of this “gift,” you need to understand the potential pitfalls you may face — financially and physically. Be careful! If you don’t ask the right questions, the gift of real estate can bite you in the butt.

First, let’s consider capital gains. Cost basis is the term assigned to how much an asset is originally valued at for tax purposes. When you sell the property, the difference between the current value of an asset and the cost basis determines capital gain. If your parents leave property to you in their will, the cost basis is the current value of the home at the time of their demise. However, if they gift you the real estate while they are live, you get to inherit the original cost basis.

There really isn’t a right or wrong answer when it comes to having your parents gift their home, but there are extremely important financial considerations depending on your goals.

Consider this: Let’s say your parents bought their house in 1962 for $18,000. That is the original value of the house as well as the original “cost basis” plus any improvements they made over the years. Today, that house is worth $450,000. If you inherit the property after your parents die, your cost basis will be the actual value of the property as of the date of your parents death. Thus, your cost basis in this example would be $450,000.  This means, theoretically, if you sold the property the day after they died, you would have zero capital gains tax.

Alternatively, if your parents gift you the house when they are still alive, the cost basis remains at the original value of $18,000 plus improvements. That means if you sold the house for $450,000, you could be staring an extremely large capital gain in the face.

This may seem like a no-brainer. But, not so fast.

Challenge No. 1: Depending on your parents’ age, health and future plans, they might not be so interested in handing over the deed just yet. This is a delicate conversation that must be approached carefully. Speak with a family lawyer or financial advisor for guidance.

Challenge No. 2: Be Sure about Current Mortgages: Even though your parents may want to gift you their property, an existing mortgage on the property could be problematic. Some mortgage lenders will call in their loans when the properties are transferred to others. This means you may have to take out a new mortgage which may not be affordable in your budget.

Challenge No 3: Do you want to be a landlord? In many cases, Mom and/or Dad will still want to live in the house they gift to you. However, these days, many retirees have their eyes set on other locales. If they are moving out, you might have to (or want to) rent the property out —unless you plan to move into it full time, or use it as a vacation home.

And even if your parents still live in the home, you should be mindful of the upkeep it could take to maintain an ongoing property, especially if you live in a different city or state. Are you physically capable of taking care of the property? Do you have the money to hire someone to do it? Ka-ching!

And, now, the possible solution you may be waiting for…

Consider a QPRT: One valuable long-range estate planning tool worth your consideration is a qualified personal residence trust (QPRT). Check it out. This is a way for your parents to control the house and still live in it while also starting the gifting process. The key is that is removes the value of the home from their estate.

Not all gifts are wrapped in a shiny box with a bow. Make sure you ask questions, as soon as possible, so you can take action instead of being forced to react to circumstances beyond your control.

Ted Jenkin (@tedjenkin) is the CEO of oXYGen Financial (www.oxygenfinancial.net,) a financial advisory firm managing more than $600,000,000. Ted focuses on being your financial advisor and your financial therapist. He is a frequent guest writer for the Wall Street Journal and personal finance expert for CNN Headline News Weekend Express and The Weather Channel.  

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Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. oXYGen Financial is not affiliated with Kestra IS or Kestra AS. Kestra IS and Kestra AS do not provide tax or legal advice.

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