Keeping property in the family can get complicated
What a father’s stock portfolio, an aunt’s house, and a mother’s antique collection can teach us about family property transfers
Family members often want to transfer property, such as real estate, investments, and personal possessions, to one another. Some do so out of generosity, love, and affection – and others do so as part of an estate-planning strategy. The bottom line is that these types of transfers can occur in myriad different ways, and for any number of reasons. While family transfers can be useful to accomplish a particular goal, taxpayers don’t always consider the tax consequences.
This article will look at a few examples of property transfers between family members, the motivations that underlie them, and the tax complications that can result.
Example 1: Adding a joint owner
A father is concerned about arranging for a transfer of his stock portfolio to his daughter through his will, because he wants to avoid state-level probate court proceedings when he dies. He makes her a joint owner of his brokerage account so that it will pass to her automatically at his death.
The tax consequences of this decision depend on the type of joint ownership that the father has set up. A common form of joint ownership is called a joint tenancy with rights of survivorship. This arrangement gives both joint owners equal rights to the property, so either owner can make withdrawals. At the first joint owner’s death, the property automatically passes to the other owner.
After the father creates the joint ownership, there is limited guidance on how that income should be taxed. In many cases, it will continue to be taxed to the owner who originally contributed the property to the account, which would be the father in this case.
The creation of the joint ownership alone doesn’t result in a taxable gift, but if the daughter withdraws funds from the account, that amount would be treated as a gift. Any withdrawal over a certain threshold means that the father would have to file a gift tax return.
If the daughter survives her father, then all the assets remaining in the account at that time will receive a new basis equal to their fair market value. Basis is used to determine gain or loss when the assets are later sold. It normally equals the sales price the owner originally paid for the property, but, in most cases, this special fair market value rule applies to inherited property. If the father survives his daughter, the account assets will not receive a new basis.
The takeaway: Joint ownership arrangements can be beneficial from an estate-planning perspective, but taxpayers should understand the possible results, especially when it comes to unexpected gift taxes.
Example 2: Creating a life estate
An aunt wants to make sure that her home goes to her niece, but the aunt still wants to live in that home. The aunt creates a life estate for herself and transfers a remainder interest in the home to her niece.
The aunt’s retained life estate means that she is considered the owner of the home while she is alive. She is still responsible for paying any expenses related to the home, such as mortgage interest, property taxes, and utilities.
If the aunt sells the house, the income tax results can become complicated. Assuming she didn’t make any improvements, the basis would likely equal the house’s original purchase price. In that case, the basis would be divided between the aunt and the niece, based on IRS actuarial tables. The aunt and the niece would each receive a portion of the sale proceeds. They would each measure their share of the gain or loss against their allocated share of the total basis.
Gain from a sale of a personal residence can usually be excluded from gross income. In this case, the aunt would likely qualify for this exclusion. However, if there was a gain on the sale and the niece did not ever use the home as her personal residence, she wouldn’t be able to exclude that gain.
After the aunt’s death, ownership would pass to her niece and the home would receive a new basis equal to its fair market value on the date of death.
The takeaway: Creating a life estate can add certainty to an estate plan. But if the owners decide to sell while the life estate still exists, they should be prepared to do some math and pay some tax.
Example 3: Making an outright gift
A mother is concerned about federal and state estate taxes that her family members will owe on a long-held collection of rare antiques, as well as the income taxes they might owe on a sale of the items. She transfers ownership of the items (valued at about $2 million) to her son through a written sales contract. She receives nominal consideration of $1 in exchange from her son to execute this “sale.”
While she may call it a sale, the mother actually made a gift. The $1 she received should not be treated as a true sales price, and she should not report it as a sale on her income tax return. Instead, she should file a gift tax return and pay any associated gift tax on the value of the antiques.
If she hasn’t made any prior taxable gifts during her life, she will not owe any gift taxes. The IRS allows a lifetime exclusion against gift tax for gifts up to $5.43 million (adjusted annually for inflation).
After the mother relinquishes all control over these items, she won’t have to include them in her estate. However, the gift tax reporting requirements will nullify most or all of the estate-planning benefits, because the taxable gift will reduce the exclusion available to the estate at the mother’s death.
The son may also experience tax effects here due to the basis rules that apply to gifts. Generally, inherited items receive a fair market value basis as of the date of death. In this case, because the mother gifted the antiques to her son, the antiques will likely maintain the same basis that the mother had immediately before the gift. This means that if the son sells the items in the future, he will likely realize a higher taxable gain.
The takeaway: Making a gift may not provide as much estate tax protection as a donor thinks it will. The taxable gift will reduce the amount of the estate tax exclusion available, and the recipient will not receive a fair market value basis.
As these examples demonstrate, there are potential tax benefits and pitfalls associated with different types of family property transfers. What seems simple can sometimes result in unintended tax consequences. But with proper due diligence and planning, these transfers can be executed with no surprises and benefits for all involved.