As you enter into retirement and look into estate planning, one concern is finding ways to share your wealth with your heirs without incurring transfer taxes or depleting your exemptions. The basic principle works a little like this: If you give something away while you are alive, it will not be in your estate when you die. Therefore, your heirs will not have to pay taxes on it. But what if you want to sell your home now and distribute a portion of the sales to your children? According to experts, it’s not quite so cut and dry.
Tax Free Gifts
If you’re thinking of selling the family home outright and simply distributing the proceeds, be prepared for a limit on how much you can dole out. The IRS permits individual gifts of up to $12,000 tax-free every year. Filing a simple gift tax return allows your spouse to join in with his or her own gift of $12,000 to the same person, making for a total of $24,000 tax-free. There is no limit to the number of individuals you can give to.
While this provision is an easy way to give money, it can take years to transfer a significant amount of wealth. Anything over and above $12,000 is possible, but you will have to fill out an informational tax return. And you may be heavily taxed on the gift.
Ways to Give Beyond the $12,000 Limit
There are other ways around the $12,000 limit. Teri Tornroos, a financial planner and tax adviser with Evergreen Financial Planning, suggests looking at where the money will ultimately go. “If you’re paying for somebody’s medical bills or education, that gift is not taxable, provided the money bypasses the person and goes directly to the institution,” says Tornroos. “You could help pay your grandson’s tuition and still be eligible to give him the $12,000 for his own expenses.” As long as the payments are made directly to the school or health care provider, they're exempt from gift tax and will not affect any of your exemptions or annual exclusions.
A second option is not selling the house at all. “If you want to leave the house to your kids, the best thing to do is to own the house and have your children inherit it,” says Bruce Julien, a registered investment advisor. “That way there is no income tax on it.”
Experts say signing over the house to your children is not advised. “Putting your kid’s name on a house is a huge mistake,” says Julien. “It removes the tax-free step up in basis. If the kids go to sell it, it becomes a huge problem with a lot of liability issues.”
In general, it's the estate that pays any taxes that are owed on the assets. But most Americans don’t pass down enough to trigger inheritance taxes. The IRS permits each U.S. citizen to give away a certain amount of money or property during his or her lifetime without paying any federal gift tax, by using what’s called the “Unified Credit Amount.” In 2009, the unified credit amount increases to $3.5 million per person.
If you’re still unsure about what to do, it’s always helpful to sit down with a planner to examine all the issues at hand. An estate-planning attorney can also help. And of course, make sure you’ve taken care of yourself before you decide how much to dole out to your family. “If you have a nice pension coming in, along with social security and maybe some interest income, then you’re in a good position to give,” says Julien. “But always wait until you’re financially comfortable before you start giving your money away.”