Some families attempt to manage their own estate planning. For those who own a home and plan to eventually leave the home to children or other relatives, they may change the way the property title is held in an effort to make the transfer of ownership easier upon their death. However, without the counsel of a North Carolina estate planning or tax lawyer, these do-it-yourself methods may result in significant tax liability for the children.
For example, an aging unmarried parent who owns real property only in their name decides to modify the title of their home to add a child as a current owner who, upon the parent’s death, will receive full interest in ownership. When selling the home, the child may then be responsible for taxes on the capital gains (see below) that result. The capital gains and resulting tax will, in most cases, be higher if the parent gives the child ownership in the property during the parent’s life versus leaving the property to the child upon death.
What if the child had a sibling and the parent instructed the child with ownership to share half of the proceeds from selling the home with their sibling? Not only will the child with ownership have to satisfy taxes as a result of the home sale, the IRS will treat the transfer of half of the sale proceeds as a gift of the child’s own money to the sibling. In this type of situation, the child who owns the home must consider:
- Adjusted cost basis. Capital gains tax is based on an adjusted cost basis. Calculating the adjusted cost basis of your home in North Carolina is done by totaling the cost of improvements made to the home, the cost of selling the home (attorney’s fees, real estate commissions), and the expenses to purchase the home (inspections, transfer fees, attorney’s fees), and adding this to the home’s purchase price.
- Capital gains tax. Once the adjusted cost basis has been determined, subtract this figure from the amount the home now sold for. (There are certain capital gains tax exemptions that individuals should review with their North Carolina tax attorney.) The difference is the amount that is taxable as capital gains. In North Carolina in 2014, the capital gains tax rate could be as high as 29.6% (the top federal rate of 23.8% combined with North Carolina’s income tax rate of 5.8%), depending on your income
- Gift tax. In the example above, if the child who owned the home honors the parent’s wishes and gives the sibling half the proceeds, the child making the gift will likely need to file a gift tax return. The IRS requires one to report gifts totaling over $14,000 made to another person during the year.
For estate planning purposes, relying on how one holds title for real property is a poor planning move. Many of the taxes reviewed above could be avoided or minimized if the parent used a trust or life estate to hold title of the property.