Answering readers' estate tax questions

Personal Finance

Questions about estate tax

May 29, 2007|By Eileen Ambrose | Eileen Ambrose,Sun Columnist

Taxes and estate issues are tricky. Not surprisingly, last week's column on the tax consequences of putting children's names on the deed of a parent's house raised questions from readers.

Here are the answers:

Raphael of Baltimore sold a house he inherited from his father and gave $28,000, the majority of the proceeds, to his son and daughter-in-law.

"Am I liable for any taxes on the sale of the house?" he asks in an e-mail. "And if I gifted the bulk of the money that I received in the sale, can I deduct it on my income taxes?"

When Raphael inherited the house, his basis for capital gains tax purposes was the fair market value at the time of his father's death, says Michael W. Davis, an estate planning lawyer in Columbia. Once he sold the house, any gains or losses realized would be reported on his federal and state income tax returns.

If the house had been Raphael's primary residence for two out of the last five years before the sale, he would be able to avoid taxes on the first $250,000 of gains, or $500,000 if married, Davis says.

Now the gift tax question. Raphael can give a total of $24,000 - $12,000 apiece - to his son and daughter-in-law each year without triggering gift tax issues. Since he gave more, he should file a Form 709 Gift Tax Return, Davis says.

Still, that's not enough to trigger gift taxes, although the extra $4,000 will be deducted from his unified credit, Davis says. That credit allows someone to give away $1 million over their lifetime without tax.

"I do believe that Raphael may be somewhat confused in that gifts are not taxable as income to the recipient, nor are they deductible from income of the donor," Davis says. "This is a common mistake."

Stephen of Chestertown says his mother put her six children on the deed to her home. She died last fall. Stephen says he's confused about the tax situation once the house is sold.

"I was told by one accountant that the one sibling that was still living at the house would have no tax liability and that the rest of us would be liable for capital gains tax based on the net difference of what the house was valued at the time the deed was assigned to us and the final selling cost of the house," he writes in an e-mail. "Could you please give me more explanation of what our actual tax liabilities will be?"

That's partly right.

Your mother made a gift to her children by putting their names on the deed. Her cost basis - what she originally paid for the house - would be divided equally among the six children, says Bill Cronin, a Lutherville certified public accountant. The cost basis is not the value of the house when the children's names were added to the deed.

Say your mother bought the house years ago for $96,000. The six children's cost basis is $16,000 each.

If the house is later sold for $180,000, each child receives $30,000 from the sale. The children not living in the house will owe taxes on the $14,000 difference between the cost basis and the sale proceeds.

The exception is the sibling living in the home. As noted above, if this is your sibling's principal residence and he or she meets the two-year residency test, the sibling won't owe taxes on the first $250,000 of gains.

Charles of Aberdeen wondered if it's true that heirs would receive a step-up in basis if they inherit a house under a "life estate deed."

A "life estate deed with powers" was the subject of last week's column. This deed would allow a parent to live in a home and have the power to sell it if she wanted, yet upon her death the house would go to heirs without undergoing probate.

Yes, heirs inheriting houses under life estate deeds get a step-up in basis, lawyers agree.

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