
When it comes to transferring property, the method of transfer—whether as a gift or an inheritance—can have significant tax implications. Understanding these differences is crucial for both the giver and the recipient. This article will delve into implications of a homeowner signing over a home to a child (or another beneficiary), including whether it is treated as a completed gift or a de facto life estate. Finally, we will discuss who qualifies for the Section 121 home gain exclusion and the impact of the original homeowner still residing in the home.
Completed Gift vs. De Facto Life Estate - When a homeowner signs over the home to a child (or other beneficiary), the tax implications depend on whether it is treated as a completed gift or a de facto life estate.
- Completed Gift - If the homeowner transfers the title and does not retain any interest in the property, it is considered a completed gift. A gift tax return is required, and the child's basis is the parent's adjusted basis at the date of the gift. If the child sells the home, the Section 121 home sale exclusion does not apply unless the child meets the Section 121 qualifications of owning and living in the home for two out of the five years counting back from the sale date.
- De Facto Life Estate - If the homeowner transfers the title but retains the right to live in the home for their lifetime, it is considered a de facto life estate. The value of the home is included in the decedent's estate, and no gift tax return is required. The beneficiary's basis is the FMV at the date of the decedent's death.
- Homeowner Establishes a De Facto Life Estate and Continues Living in the Home
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Impact on Homeowner:
- Estate Inclusion: The value of the home will be included in the homeowner's estate upon their death, per Section 2036 of the Internal Revenue Code.
- No Gift Tax Return: Since the homeowner retains the right to live in the home for their lifetime, there’s no completed gift and no gift tax return is required.
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Impact on Beneficiary:
- Basis of Property: The beneficiary's basis in the property will be the Fair Market Value (FMV) at the date of the homeowner's death.
- No Immediate Tax Implications: It wouldn’t be the beneficiary’s responsibility to file/pay the gift tax in any case
- Homeowner Moves Out of the Home After Transferring Title
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Impact on Homeowner:
- Gift Tax Return: Since the homeowner no longer resides in the home, a life estate is not established, and the transfer is considered a completed gift. A gift tax return is required.
- Adjusted Basis: The homeowner's adjusted basis in the home at the date of the gift will be used to determine the gift's value.
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Impact on Beneficiary:
- Basis of Property: The beneficiary's basis in the property will be the homeowner's adjusted basis at the date of the gift.
- Section 121 Exclusion: If the beneficiary sells the home, they cannot use the Section 121 home sale exclusion unless they meet the two-out-of-five-years use and ownership tests.
- Homeowner Dies While Still Residing in the Home
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Impact on Homeowner:
- Estate Inclusion: The value of the home will be included in the homeowner's estate, similar to the first scenario. Whether a Form 706, Estate Tax Return, is required will depend on the total value of the estate.
- No Gift Tax Return: No gift tax return is required since the homeowner retained the right to live in the home for their lifetime.
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Impact on Beneficiary:
- Basis of Property: The beneficiary's basis in the property will be the FMV at the date of the homeowner's death.
- Tax Implications: The beneficiary does not need to file a gift tax return or pay gift taxes at the time of the homeowner's death. If the beneficiary sells the home, they cannot use the Section 121 home sale exclusion unless they meet the two-out-of-five-years use and ownership tests.