OK, so let’s say your widower father decides he really doesn’t need the big family house any more, that he’d be better off in a nice, smaller place. And he knows that you’re just starting a family, you’re doing OK but not great financially, and realistically it may be awhile before you and your husband can realize your dream of owning your own home. He offers to give you the house when he moves out. He’s in very good shape financially, so he can do this comfortably.
Terrific, right? Everybody’s happy, you have a great house well before you anticipated, and your father gets to feel like he’s done you a wonderful favor.
There’s a problem though. If he just gives you a big ticket item like that as a gift, he’s looking at having to pay a sizable gift tax on it.
But let’s take a little closer look at the gift tax.
There is no gift tax on the first $13,000 in gifts each year. Anything beyond that counts toward a lifetime nontaxable $1,000,000. In other words, if he gave you $20,000 as gifts this year, $25,000 next year, and $22,000 the year after that, he’d have “used up” $28,000 (the “extra” beyond the first $13,000 each year) of the lifetime $1,000,000.
Now at first glance, you might say, “OK, no big deal. The house is worth less than $1,000,000.” But the problem is, even if his lifetime extra gifts don’t go beyond the $1,000,000, that counts toward the minimum for the estate tax when he dies. If, counting the house, he’s given $600,000 extra lifetime beyond that $13,000 per year, then yes, there’s no gift tax, however, when he dies it’ll be treated as $600,000 of his estate having already been disbursed, which, depending on how much is left, may mean paying an estate tax.
So, if the house would go over the lifetime $1,000,000 for the gift tax, or if there is likely to be a big enough estate that the value of this house will make a difference as to whether there will be an estate tax levied, it would be better to transfer the house to you in a way that doesn’t count as a gift.
To achieve that, what you could do is purchase the home from him, say for $700,000. Then have him finance the entire $700,000, like a bank loaning you money to buy the house.
Each month, you would then pay your father money toward paying off what in effect is a mortgage loan.
Note, be sure to set up the loan to include interest. One, because an interest-free loan again brings the gift tax into play. The IRS will calculate how much of a “break” you’re getting by not paying the Applicable Federal Rate of interest, and count that as a gift. Two, because if your monthly payment is all or partly going toward interest, you may be able to use it for a deduction on your tax return.
Each year, your father could give back $13,000 of what you’ve paid him (or if you paid less than $13,000 that year, he could forgive the difference from the remaining loan) to keep it within the yearly gift maximum. Or really $26,000, as $13,000 could be a gift to you, and $13,000 to your spouse.
Then if he dies, the balance of the loan can be forgiven in his will.
But to work out the details and ramifications of any such arrangement, be sure to consult a tax professional.